Currency
Trading Basics
All currency trades
involve the buying of one currency and the selling of another, simultaneously.
Currency quotes are given as exchange
rates; that is, the value of one currency relative to another. The relative
supply and demand of both currencies will determine the value of the
exchange rate.
When a currency
trader places a trade he wants the currency purchased to appreciate
in value versus the currency sold. His ability to determine the direction
that the exchange rate will move, will dictate his gain or loss in a
trade. Let's do an example with a currency quote obtained from the forex
trading system.
Hypothetical Example
of a forex trade
The current bid-ask
price for EUR/USD is 1.0120/1.0126, meaning you can buy 1 euro (EUR)
for 1.0126 US dollars (USD). [If you need
help understanding how to interpret forex quotes, click on this link.]
Suppose you feel
that the EUR is undervalued against the dollar. To execute this strategy,
you would buy Euros (simultaneously selling Dollars) and then wait for
the exchange rate to rise.
So you make the
trade: purchasing 100,000 EUR (1 lot) and selling 101,260 Dollars. (Remember,
at 1% margin, your initial margin deposit would be 1,000 Euros.)
As you expected,
EUR/USD rises to 1.0236/42. Since you bought Euros and sold Dollars
in your previous trade, you must now sell Euros for Dollars to realize
any profit. You can now sell 1 EUR for 1.0236 Dollars. When you sell
the 100,000 Euros at the current EUR/USD rate of 1.0236, you will receive
102,360 USD.
Since you originally
sold (paid) 101,260 USD, your profit is US $1100 (please note: if the price of the Euro against the US Dollar would have gone down instead of up by the same amount in the example above, there would have been a loss of $1100 instead of a profit. A possibility for profit is always accompanied by a risk of loss).
Total profit = US
$1100.00
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