How Trade Make Money in Forex

This post starts with an explanation of how currencies are bought
or sold in the market. We then decode a forex contract for long
and short. The chapter also explains the three critical points in
every trade and points out the bid/ask spread that brokers charge for
each trade. This chapter also presents the four reasons that cause cur-
rencies to fl uctuate on a daily basis. We then turn to the fraction the-
ory, which helps us to decide on a long or short trade. The chapter ends
with an explanation of how charts are read and how market structure is
identifi
ed.
BUY LOW, SELL HIGH
Forex traders make money by speculating on the movement of currency
rates. There are only two ways to do this. The fi rst way is to buy, expecting
prices to rise. The second way is to sell, expecting prices to fall.
Buy
The current rate for AUD/USD is now 1.0325. You enter into a buy posi-
tion because you expect the Australian dollar to strengthen further
against the U.S. dollar. A buy trade is termed a “long position” in the
forex market.
After three hours, the AUD/USD rate is at 1.0375. You were right, and
you made 50 pips on this trade. Another way of saying this is that your
long position took profi t. Let ’s have a look at Example 2.1 for an exact
contract.
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16
FOREX IS A GAME
EXAMPLE 2.1: BUY AUD/USD AT 1.0325
Let
’s assume that you buy 100,000 Australian dollars for this contract, or
one standard lot. Since the exchange rate is 1.0325, you pay AUD100,000
with USD103,250.
After three hours, the AUD/USD rate goes up to 1.0375. You then sell
the AUD100,000 and receive USD103,750. This transaction nets you a
total profi t of USD500.
Action
AUD
USD
Buy AUD100,000 at the current
AUD/USD rate of 1.0325.
1
100,000
2
103,250
3 hours later, sell AUD100,000
at the rate of 1.0375.
2
100,000
1
103,750
Total profit earned USD
500
0
1
500
If you did not use leverage, you had to fork out USD103,250 to make
USD500. Percentage-wise, your return is only 0.484% (500/103,250).
However, if you utilized leverage of 100:1 provided by the broker,
you would only have needed to lay out margin of USD1,032.50 to buy
AUD100,000. Percentage-wise, your return would have been a whopping
48.4% (500/1,032.50).
EXAMPLE 2.2: SELL EUR/USD AT 1.3142
Let
’s assume that you sell 200,000 euros for this contract, or two stan-
dard lots. Since the exchange rate is 1.3142, you receive USD262,840 for
200,000 euros. After two hours, the EUR/USD rate goes down to 1.3112.
You then buy back the 200,000 euros and pay USD262,240. This
transaction nets you a total profi t of USD600.
Sell
The current rate for EUR/USD is at 1.3142. You enter into a sell position
because you expect the euro to further weaken against the U.S. dollar. A
sell trade is termed a “short position” in the forex market.
After two hours, the EUR/USD rate is at 1.3112. You were right, and
you made 30 pips on this trade. Another way of saying this is that your
short position took profi t. Let ’s have a look at Example 2.2 for an exact
contract.
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How Money Is Made in the Game
17
Action
EUR
USD
Sell 200,000 euros at the current
EUR/USD rate of 1.3142.
2
200,000
1
262,800
2 hours later, buy back 200,000
euros at the rate of 1.3112.
1
200,000
2
262,240
Total profit earned USD
600
0
1
600
Similarly, If no leverage was employed, you had to utilize 200,000
euros, or USD262,840, to make USD600. Percentage-wise, this represents
a return of only 0.228% (600/262,840).
However, if you utilized leverage of 100:1 provided by the broker,
you would only have needed to lay out margin of USD2,628.40 to sell
200,000 euros. Percentage-wise, your return would have been a whop-
ping 22.8% (600/2,628.40).