To show you how Forex trading works, we’ll review in this article some Forex trading examples.
For that, we will use illustrations with the following leveraged financial products: spread bets, CFDs, and Spot FX.
You can use these products through different trading platforms, but you need to remember that they are mostly used for scalping, or day trading.
Indeed, leverage and margin trading is useful for those using active trading strategies that rely on short-term price movements to make profits.
SOME FOREX EXAMPLES
A reminder
In a currency pair, the first currency in the pair the one on the left is always called the base currency. The second currency the one on the right represents the quote (or counter) currency
In Forex trading, you’re always investing in currency pairs depending on your scenario. If you think that the base currency will strengthen against the quote currency, you would buy the currency pair. Conversely, if you believe that the value of the base currency will weaken against the quote currency, you would sell the currency pair
In a quote, the price on the left is always the bid price (or sell price), while the price on the right is the ask price (or buy price)
Spot Forex is traded with specific amounts called “lots”. They are the equivalent of 100,000 units of the base currency. Forex brokers now offer different kinds of “lots” in order for their traders to adapt their trading strategies to their trading capital and market conditions. There are mini, micro, and nano lots, which are 10,000, 1,000, and 100 units respectively
In the following examples, margin as well as profit/loss (P&L) will be calculated, and denominated, in the quote currency of the pair.
That said, when Forex spread betting, the P&L is usually in the account currency, which will be the USD.
SPOT FX – GOING LONG ON THE EUR/USD
The EUR/USD exchange rate is 1.1737/ 1.1739.
Scenario:
Because you believe that the currency pair is going up, you decide to buy $10,000 of the EUR/USD, with a margin rate of 0.10%.
The margin represents the amount of money you have to put aside to be able to open your trading position. In our example, that’s 0.10% of your total position value.
Therefore, your margin would be $11.737 [0.10%*(10,000*1.1737)].
Outcome 1 - Winning trade
Your prediction was correct, and the currency pair went up within the next hours to 1.1801 / 1.1803.
You decide to close your position by selling it at the current selling price of 1.1801.
The currency pair has then moved 64 pips in your favour (1.1801 – 1.1737). It means that your profit reached $64 [($10,000*1.1801) – ($10,000*1.1737)].
Outcome 2 - Losing trade
Unfortunately, the market didn’t evolve in the direction you predicted: the currency pair dropped quickly to 1.1673 / 1.1675. As you thought that it would keep falling, you decide to cut your losses: you close your position at the current sell price of 1.1673.
The currency pair moved 64 pips against you (1.1673 – 1.1737). This means that your loss reached $64 [($10,000*1.1673) – ($10,000*1.1737)].
CFDS – GOING LONG ON THE AUD/USD
The AUD/USD currency pair trades at 0.7406 / 0.7408.
Scenario:
Because you believe that the AUD/USD will going up, you decide to buy one standard contract at 0.7406 – or 7,406 points.
In this situation one point equals $10.
To find out the margin you need to put aside, you need to use the following computation:
number of contracts*value of one contract*current price level*margin rate = 1*10*7,406*0.50% = $370,3
Outcome 1 - Winning trade
The market goes up within the next few hours to 0.7500 / 0.7502.
You decide to take your profit by selling at the current selling price of 0.7500 – or 7,500 points.
The currency pair moved 94 pips in your favour (7,500 – 7,406).
As each contract is worth $10 per point, and as the currency pair went up 94 points, your profit equals $940 (10*94).
Outcome 2 - Losing trade
Unfortunately, the market quickly dropped 100 points to 0.7306 / 0.7402. You decide to close your position at the current selling price of 7,306.
Your loss would then equal $1,000 (10*100).
SPREAD BET – GOING SHORT ON THE GBP/USD
The GBP/USD currency pair trades at 1.3127 / 1.3129.
Scenario:
Because you believe that the currency pair is going down, you decide to sell $10 a point at 1.3127. Your broker requires a margin of 0.50%
To find out the margin you need to put aside, you need to use the following computation:
Size of your bet*current price level*margin rate =
10*13127 *0.50% = $656,35
Outcome 1 - Winning trade
The market accelerates down to 1.3027 / 1.3029.
You decide to take your profit by closing your position at the current buying price of 13029.
The currency pair has moved 100 pips in your favour (13027– 13127).
As your bet size is worth $10 per point, and the currency pair went down 100 points, your profit* equals $1,000 (10*100).
Outcome 2 - Losing trade
Unfortunately, the market quickly rose 100 points to 1.3227 / 1.3229. You decide then to close your position at the current buying price of 13229.
Your loss would then equal $1,000 (10*100).
BOTTOM-LINE
While currencies rise and fall in relation to other currencies in the wake of national as well as international economic, financial and geopolitical events, you can take advantage of these movements through either spread betting, CFDs trading, or FX cash trading.
In our examples, we didn’t use stop-loss or take-profit orders, which means that risk/reward was not limited. To avoid large losses when the market goes against you when trading the Forex market, you should have a sound risk and money management system.
Work on creating a trading environment where you control the risks:
Identify the currency pair you want to invest in
Choose how you’re going to trade it: spread bets, CFDs, or FX cash
Understand how margin, leverage, and holding costs will impact your trading account and your P&L
Adapt the size of your positions to your trading account and to market conditions in order to choose the appropriate leverage
Always cap your losses with strategic stop-loss orders