What Is Trading? How Buying and Selling for Profit Works
Trading is buying and selling an asset, such as a currency, a stock, a commodity or a bond, to profit from changes in its price. You buy when you expect the price to rise and sell when you expect it to fall, usually holding the position for minutes, days, weeks or months rather than years.
This matters because a trade puts real money at risk as soon as you open it. You also pay a cost before the price has moved at all. If you understand how a trade works before you place one, a few bad trades are less likely to empty a first account.
Trading vs investing: the difference is how long you hold
Investors buy assets and hold them for years to capture long-term growth. Traders want shorter-term gains: they buy and sell often and react to price movements along the way.
Because a trader holds for a short time, even a small trading cost takes up a large share of a small price move.
The main trading styles: day trading, swing trading and position trading
Traders are usually grouped by how long they hold a trade.
- Day trading: you open and close every trade within the same day, so no position is held overnight.
- Swing trading: you hold a trade for a few days to a few weeks to catch one price swing, often reading 4-hour and daily charts.
- Position trading: you hold for weeks or months to follow a larger trend. It sits closest to investing, but the aim is still to profit from the price change, not to own the asset for years.
The shorter the hold, the more trades you take, and the more often you pay the spread: the small gap between the buy and sell price, which you pay on every trade.
What can you trade: currencies (forex), stocks, indices, commodities and crypto
Trading covers several markets. In some of them you buy the asset itself. In others you trade a contract whose value follows the asset's price.
How the main markets differ, in one line each:
- Currencies (forex): you trade one currency against another as a pair, such as EUR/USD; retail forex trades through a dealer firm rather than a central exchange.
- Stocks: you trade shares of one company, so the price follows what buyers and sellers think that company is worth.
- Indices: an index is one number that tracks a group of stocks, so you trade the whole group at once instead of a single company.
- Commodities such as gold and oil: you trade raw materials, usually through futures contracts or CFDs rather than the physical goods.
- Crypto: you trade digital coins such as bitcoin, either on a crypto exchange or through a CFD.
A CFD (contract for difference) is an agreement with your broker to settle the difference between the price when you open a trade and the price when you close it. You never own the asset, so betting on a fall (going short) is as easy as betting on a rise (going long). A futures contract is a standardised agreement to buy or sell a set quantity of an asset at a fixed price on a future date. It trades on a regulated exchange, and the exchange's clearing house guarantees both sides.
| Market | What you trade | Do you own the asset? | Going short (betting on a fall) |
|---|---|---|---|
| Stocks | Shares of a company, or a CFD on them | Yes with real shares, no with a CFD | Possible: the broker lends you shares. Built into a CFD |
| Currency pairs (forex) | One currency against another, through a retail dealer firm (broker) | No, you hold a position, not the currency itself | Built in: selling EUR/USD means selling euros and buying US dollars at the same moment |
| Commodities (gold, oil) | Futures contracts or CFDs | No, you trade a contract | Built into both |
| Indices | Futures contracts or CFDs | No with futures or CFDs, you trade a contract on the index's level | Built into both |
| Crypto (bitcoin and other coins) | Coins on a crypto exchange, or a CFD on them | Yes when you buy the coins, no with a CFD | Built into a CFD. Holding the coins only profits if the price rises |
Where your profit comes from, and where your loss goes
A price is simply the last level at which a buyer and a seller agreed to trade. When you sell a share for more than you paid, the extra comes from the buyer who paid your price. Nobody else has to lose for the price to rise; buyers simply agreed to pay more.
In retail forex the dealer firm you trade through, called a market maker, may take the other side, so your profit may be its loss and your loss its gain. Because retail forex has no single central marketplace, it can also be harder to confirm that the dealer is giving you a fair price. The arithmetic for your result is the same in every market:
Result = (exit price - entry price) × position size - costs
Costs means any commission and, if you hold overnight, swap, a financing charge on leveraged forex and CFD positions. The spread is already inside your entry and exit prices, because you buy at the ask (the higher of the two quoted prices) and sell at the bid (the lower one). On a short you flip the subtraction:
On a short: Result = (entry price - exit price) × position size - costs
Going long and going short: profit in either direction
Going long means you buy first and sell later. You make money if the price rises.
Going short means you sell first and buy back later. You make money if the price falls. Many beginners get stuck here because they wonder how you can sell something you do not own.
Think of it like borrowing a friend's concert ticket while tickets sell for $100. You sell it, the price drops to $80, you buy one back and return it, and you keep $20. With stocks, your broker handles the borrowing behind the scenes.
Suppose you short 10 shares at $50 and buy them back at $45. You make ($50 - $45) × 10 = $50. The chart below shows that trade. You would also set a stop loss, a price chosen in advance that closes the trade automatically if the market goes against you; here it sits at $52. If the price had risen to $52 instead, you would have bought back higher and lost 10 × $2 = $20.
The most common misread: you are in a short and you see the price go up, then wonder why your account went down. On a short, a rising price is a loss. Before every order, finish this sentence: "I make money if the price goes ___."
Why prices move at all
A price moves when one side is more eager than the other. If more traders want to buy at the current price than want to sell, buyers have to offer more, and the price rises. If sellers are more eager, they have to accept less, and the price falls.
News is what usually changes that balance. An interest rate decision, a company's earnings report or a fresh economic figure changes what traders expect an asset to be worth. They buy or sell to match their new view, and the price moves to a level where buyers and sellers agree again.
Studying those drivers is called fundamental analysis. Studying the price history itself on a chart is called technical analysis. Either way, you are trying to judge which side will be more eager next.
How a trade works, step by step
These are the steps of a single trade, in the order you take them.
- Choose the market and the direction. Pick one instrument, such as a stock or a currency pair, and decide whether you are going long or short.
- Set your exit levels before you enter. Place your stop loss at the level where your idea has failed. A take profit closes the position automatically at your target.
- Work out the size. Use the lots formula in the section on how much to risk per trade so a hit stop costs no more than 1% of your account.
- Place the order. A market order fills straight away at the current price: buys fill at the ask and sells fill at the bid, the two prices the next section explains. A pending order waits and fills only when the price reaches a level you choose.
- Close the position and count the result. Your stop loss or take profit closes it, or you close it by hand.
The chart below shows the difference in step 4. A market order fills at once at the current price. A pending buy placed above the price (a buy stop) opens nothing until the price climbs to it.
With shares the count is simple. Buy 10 shares at $50 and sell them at $53, and you make 10 × $3 = $30. Forex counts the same thing, price change times size, but it measures the change in pips and the size in lots, as the section on how much to risk per trade shows.
Bid, ask and the spread: the cost you pay on every trade
Every market shows two prices. The bid price is the price you can sell at. The ask price is the price you can buy at, and it is always a little higher.
The gap between them is the bid-ask spread. You pay it as a cost on every trade, even before any commission.
In forex, the gap is measured in pips. A pip is the standard unit for measuring a price move: for most pairs it is the fourth decimal place (0.0001), and for pairs quoted in Japanese yen it is the second decimal place (0.01).
For example, say EUR/USD shows a bid of 1.1000 and an ask of 1.1002. You buy at 1.1002. If you closed straight away, you would sell at 1.1000, so you start 2 pips down. The chart below shows that gap.
In forex, most charts draw the bid price, but a sell closes at the ask, which sits above that line. If the spread widens, a sell's stop can be hit even though the chart price never touched it. So place a sell's stop at least the normal spread above the level you care about.
Spreads tend to widen when trading volume and liquidity are low or when volatility is high. They narrow in heavily traded markets. Use this rule: if the spread on your pair is wider than normal, wait. A wide spread can push the closing price into your stop.
How much to risk per trade
Forex sizes a trade in lots, counted in units of the base currency (the first currency in the pair, for EUR/USD the euro): a standard lot is 100,000 units, a mini lot 10,000, a micro lot 1,000 and a nano lot 100.
On pairs where the US dollar is the second currency, such as EUR/USD, one pip is worth about $10 per standard lot, $1 per mini lot, $0.10 per micro lot and $0.01 per nano lot. The formula to copy is profit or loss = pips moved × pip value per lot × number of lots.
Size every trade from the amount you accept losing, not from the profit you hope for. This lesson uses the 1% rule: risk no more than 1% of your account on any one trade. Then work out the size with this formula:
Lots = money at risk ÷ (stop distance in pips × pip value per standard lot)
The answer comes out in standard lots, because the formula uses the $10 pip value of one standard lot. For example, you have a $1,000 account and risk 1% per trade, which is $10. Your stop is 20 pips away. $10 ÷ (20 × $10) = 0.05 lots, which is five micro lots. The drawing below works through each step and checks the answer.
For shares the rule is the same: Shares = money at risk ÷ distance to the stop in dollars. For example, $10 ÷ $2 = 5 shares.
Illustrative worked example: how one trade makes or loses money
The figures below are an illustrative example, using 1 mini lot to keep the dollars round (at the 1% rule you would trade half that). You have a $1,000 account. EUR/USD shows the same quote as above: bid 1.1000, ask 1.1002. You expect it to rise, so you buy 1 mini lot, which is worth $1 per pip.
- Entry: you buy at the ask, 1.1002.
- Stop loss: 1.0982, which is 20 pips below entry (1.1002 - 0.0020).
- Take profit: 1.1042, which is 40 pips above entry (1.1002 + 0.0040).
As soon as the order fills, your position shows -$2. The bid is at 1.1000, 2 pips below your entry, and 2 pips × $1 = $2. That is the spread you paid.
The calculation below shows both possible outcomes.
If the bid reaches 1.1042, the trade closes and your account grows to $1,040. If the bid falls to 1.0982, it closes at a loss and your account drops to $980. The spread is already included in both numbers, because you bought at the ask and close at the bid. The example assumes no commission and that you close the trade the same day, so no swap is charged.
What leverage does to a small account
Leverage lets you control a position much bigger than your own money, because the broker effectively lends you the rest. The part of your money set aside to open the position is called margin.
Take the same example trade. One mini lot of EUR/USD at 1.1000 is 10,000 euros, which is 10,000 × 1.1000 = $11,000 of currency. Suppose your broker asks for $500 of margin to open it. The chart below shows how small that is next to what it controls.
Leverage does not change pip value. A mini lot is still worth $1 per pip. What leverage changes is how much margin you need to open a position, and therefore how large a position your account can open.
Now look at a 1% price move. 1% of 1.1000 is 0.0110, which is 110 pips, and 110 × $1 = $110. That is 22% of the $500 margin. Because a leveraged position is worth many times your capital, you can lose your whole deposit and possibly more than that. The comparison below shows what your 20-pip stop changes.
- –Trade closes 20 pips against you
- –Loss: 20 × $1 = $20
- –2% of the account (twice the 1% rule)
- –1% of 1.1000 = 0.0110 = 110 pips
- –Loss: 110 × $1 = $110
- –22% of the $500 margin
- –11% of the $1,000 account
The main risks of trading
Every trade carries the same few risks, whatever the market:
- Price risk: the market can move against you further than you expect. Without a stop price, you have no limit on what one trade can cost.
- Leverage risk: before you open a trade, check the loss at your stop in money, not the margin.
- Cost risk: the tighter your stop, the bigger the share of it the spread uses up.
- Pricing risk in retail forex: note the bid and ask shown when you place an order, and compare them with the fill price in your trade history.
Why big daily income goals blow up small accounts, and other beginner mistakes
Sizing trades from the income you want. Say you want $800 in one day from a $150 account. That means making more than five times your account in a single day. A position big enough to do that would wipe out the account if the price moved a little the other way. Fix: do the arithmetic before you trade. To make $800 on a 40-pip target you need $20 per pip, which is 2 standard lots (800 ÷ 40 = $20). With a 20-pip stop, a loss costs 20 × $20 = $400, more than 2.5 times your $150 account. At 1% risk you can lose $1.50 per trade, so a realistic target on that account is a few dollars, not hundreds.
Trading bigger to win back a loss. Doubling your size after a losing trade doubles the next loss too. Fix: risk the same fixed amount on every trade, whatever the last trade did.
A pre-trade checklist you can copy
Run through this before every order. If you cannot fill in a line, do not trade.
- Direction: long or short, and the one-sentence reason.
- Entry: the price you will buy or sell at, and whether you use a market order or a pending order.
- Stop loss: the price, and its distance in pips.
- Take profit: the price, and its distance in pips.
- Size: worked out with the lots formula above, not guessed.
- Spread: normal for this pair right now?
- Loss in money: the exact amount you lose if the stop is hit, and whether you accept it.
FAQ
When does a trading profit become real money?
While a position is open, its profit or loss changes with every price move. Your equity, which is your balance plus any open profit or loss, changes with it. The profit is only realized when you close the position, and only then is it added to your balance. A trade that shows a profit now can still close at a loss.
Once the position is closed, the profit sits in your account balance with the broker. To get it into your bank, you make a withdrawal from that account.
Can I start trading with $100?
You can, because small lot sizes make it possible. If you risk 1% of $100, that is $1, which covers a 10-pip stop on one micro lot (10 × $0.10 = $1). Treat a small account as practice at following your process, not as a source of income.
Does the method change if I start with $5,000 instead of $500?
Only the size changes. The catch with a small account is rounding: at $500, a 20-pip stop gives $5 ÷ (20 × $10) = 0.025 lots, which is 2.5 micro lots. You round down to 2 micro lots, or use 25 nano lots, and never round up. With $5,000 the same stop gives a clean $50 ÷ (20 × $10) = 0.25 lots.
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