How Is Money Made in FOREX?

In Why Trade Foreign Currencies?, I list most of the reasons people trade currencies. But the most common reason is the potential to make a large profit with a small grubstake. Note that I said potential -- there is real risk involved.

Here is a simplified example:

Suppose I buy (go long) 10,000 EURUSD at 1.3550. If I am a U.S. trader, the broker will require me to place 2 percent of the value of the transaction in my account as margin.
In some other countries, you might need to place as little .25 percent. If I already have a funded account, that amount will be held aside for this trade -- it cannot be used as margin for another trade at the same time. My margin, for the purpose of this example, will be $200.00, which is 2 percent of 10,000.

In the next few days, the price of the EURUSD goes to 1.3650, a not untypical amount of price movement. I decide to liquidate my position. I have made 100 pips. On a 10,000 mini lot, each pip, the minimum price change, is $1.00. Thus, I profited by $100.00.

Not much in dollars, perhaps. But when margin cost of $200 is factored in, I made a 50 percent profit in a few days.

Leverage, the ability to control a large amount of an investment with a small margin, can be a very powerful tool. But like a fast sports car, it can be very dangerous if you have not acquired the skill set to handle it, or if you simply become careless.
By Michael Duane Archer
Michael Duane Archer has been an active futures and FOREX trader for more than 35 years. He has worked in various advisory capacities, notably as a commodity trading advisor, registered SEC investment advisor, and branch manager for Heinold of Hawaii. He currently trades FOREX and futures and is involved in several technical analysis research projects.

Copyrighted 2016. Content published with author's permission.

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