Buying and Selling

Financial market is a mechanism that allows people to easily buy and sell (trade) market instruments at low transaction costs and at prices that reflect efficient markets. Financial markets have evolved significantly over several hundred years and are undergoing constant innovation to improve liquidity.

If you believe value of a market instrument is going to increase, then you would buy the instrument and at one point in the future you would sell it for a higher price. This is the basic motivation for trading on financial markets.

Orders and Positions

When you want to open a position you need to place an “entry” order. If and when the entry order executes, the position becomes “open” and starts its life on the market. At some point in the future, you will place an “exit” order to “close” the position. A position can be “long” (entry order is to buy and exit order is to sell an instrument) or “short” (entry order is to sell and exit order is to buy an instrument).

At the point when you place your entry order, you need to define price level at which you want to buy or sell certain instrument. You also need to specify type of the order and quantity of the instrument you want to trade. There are 3 order types:

Market Order

Placing a market order means that you will buy at the current “ask” (or “offer”) price, or sell at the current “bid” price, whatever that price currently is. For example, suppose you are buying a market instrument and its current market price is 129.34 / 129.38. This means a participant in the market is willing to buy the instrument from you at 129.34 and / or sell it to you at 129.38.

Stop Order

Initiating a trade with a stop order means that you will only open a position if the market moves in the direction you are anticipating. For example, if an instrument is trading at 129.34 / 129.38 and you believe it will move higher, you could place a stop order to buy at 129.48. This means that the order will only be executed if ask price in the market moves up to 129.48. The advantage is that if you are wrong and the market moves straight down, you will not have bought (because 129.48 will never have been reached). The disadvantage is that 129.48 is clearly a less attractive rate at which to buy than 129.38. Opening a position with a stop order is usually appropriate if you wish to trade only with strong market momentum in a particular direction.

Limit Order

A limit order is an order to buy below the current price, or sell above the current price. For example, if an instrument is trading at 129.34 / 129.38 and you believe the market will rise, you could place a limit order to buy at 129.28. If executed, this will give you a long position at 129.28, which is 10 pips better than if you had just used a market order. The disadvantage of the limit order is that if the instrument moves straight up from 129.34 / 129.38 your limit at 129.28 will never be filled and you will miss out on the profit opportunity even though your view on the direction was correct. Opening a position with a limit order is usually appropriate if you believe that the market will remain in a range before moving in your anticipated direction, allowing the order to be filled first.

For both entry and exit orders you can specify price levels at which you want them to be executed. You have to specify entry levels when you place you entry order, while most trading systems would allow you to specify exit levels at any time.

Calculating Profit

The objective of trading is to buy a market instrument and later sell the same market instrument for a higher price. In case of margin trading, trader can also sell a market instrument first and later buy the same market instrument for a lower price. Either way, trader has to close position in order to lock in the profit.

Let us assume that you open a long position by buying a market instrument for 129.38 (quantity of 10000) and few hours after that, you close the position by selling it for 129.52 (same quantity of 10000). These two trades would bring you profit of (129.52 – 129.38) * 10000 = 1400.

We can also say that these two trades would bring you 14 “points” profit. A “point” is the smallest increment in an instrument’s price. For the instrument in the above example, one point is 0.01 and for an instrument denominated with 4 decimals, one point would be 0.0001. Expressing position profits in points is often very useful for quick calculations and estimates.

One point, from the example position above, would bring you 0.01 * 10000 = 100 profit, denominated in the same currency the market instrument is denominated in.

In case of Forex, currency pair denomination will be in the counter currency (JPY is the counter or quote currency in the USD/JPY pair) and you may need additional currency conversion to get profit calculated in the currency your trading account is denominated in.

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The object of Forex trading is to exchange one currency for another in the expectation that the price will change, so that the currency you bought will increase in value compared to the one you sold.

Example of making money by buying Euros

*EUR $10,000 x 1.18 = US $11,800
** EUR $10,000 x 1.25 = US $12,500

An exchange rate is simply the ratio of one currency valued against another currency. For example, the USD/CHF exchange rate indicates how many U.S. dollars can purchase one Swiss franc, or how many Swiss francs you need to buy one U.S. dollar.

How to Read an FX Quote

Currencies are always quoted in pairs, such as GBP/USD or USD/JPY. The reason they are quoted in pairs is because in every foreign exchange transaction you are simultaneously buying one currency and selling another. Here is an example of a foreign exchange rate for the British pound versus the U.S. dollar:

GBP/USD = 1.7500

The first listed currency to the left of the slash (”/”) is known as the base currency (in this example, the British pound), while the second one on the right is called the counter or quote currency (in this example, the U.S. dollar).

When buying, the exchange rate tells you how much you have to pay in units of the quote currency to buy one unit of the base currency. In the example above, you have to pay 1.7500 U.S. dollar to buy 1 British pound.

When selling, the exchange rate tells you how many units of the quote currency you get for selling one unit of the base currency. In the example above, you will receive 1.7500 U.S. dollars when you sell 1 British pound.

The base currency is the “basis” for the buy or the sell. If you buy EUR/USD this simply means that you are buying the base currency and simultaneously selling the quote currency.

You would buy the pair if you believe the base currency will appreciate (go up) relative to the quote currency. You would sell the pair if you think the base currency will depreciate (go down) relative to the quote currency.

Long/Short

First, you should determine whether you want to buy or sell.

If you want to buy (which actually means buy the base currency and sell the quote currency), you want the base currency to rise in value and then you would sell it back at a higher price. In trader’s talk, this is called “going long” or taking a “long position”. Just remember: long = buy.

If you want to sell (which actually means sell the base currency and buy the quote currency), you want the base currency to fall in value and then you would buy it back at a lower price. This is called “going short” or taking a “short position”. Short = sell.

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