Two terms that often create confusion for novice traders are “Long” and “Short”, especially the concept of shorting a currency.
Long or Buy
It is quite easy to comprehend buying a fx pair because it works in the same way as buying anything else for speculative purposes, namely, you buy at an agreed price, keep the asset as long as necessary, and sell it at a profit.
Short or Sell
This is usually more difficult to understand because there is not really an example elsewhere which one can use as a reference.
Let’s assume you research the market and form the opinion that the prices of red Lamborghinis are going to fall because red is not the colour of the season this winter.
Lucky for you, you have a friend with a red Lamborghini.
You approach your friend and ask whether he will be willing to lend you his car but keep it in his possession while you use it to sell in the market. He agrees and charges you 1% of the value of the car.
You immediately advertise a red Lamborghini at a price 10% less than the present value for delivery in 90 days. Because your research was well done, 60 days later, the value of red Lamborghinis fall with 15%.
You buy a red Lamborghini on the market at the cheaper price, and deliver it to your buyer of 60 days ago. When he pays you, you pay your friend his “rent” amount of 1% and keep the balance as your profit.
See how risk is contained ( Opens in new tab)
Shorting a currency
You do research and you come to believe that the value of the Euro is going to fall as measured against the US dollar.
You enter an order on your fx broker’s platform to sell 5 lots of the EUR/USD pair. In practice, your broker “lends” you the euros you are selling. It can be currency that the broker owns or currency he got from one of the large banks.
The technicality of the transaction means you actually sell EUR and buy USD (because if the EUR loses value, the USD will gain value).
Four hours later, the value of the Euro falls and you BUY Euro’s and SELL USD’s. When you repay your broker or the bank that you borrowed the currency from, you are left with a profit, which belongs to you.