Interested in currency investing? Not sure how it all works? Then read on for a simple Forex trading example!
Pretend you have opened an account with an online broker, and made a margin deposit of $1,000. Your broker offers ‘matching’, so you’re able to trade the standard lot size of 100,000 units on the 1,000 deposit.
You’ve done your research and feel pretty confident that the Euro is going to rise over the short-term, so you decide to put up 100,000 on the trade.
The market opens and your broker gives you a quote of EUR/USD = 1.4425 EUR. You sell $144,250 U.S. at this rate to purchase 100,000 EUR.
A few days later, the EUR rises to 1.4535 you decide to sell 100,000 EUR at this price, and will be paid U.S. $145,350. Without factoring in any margin spread, your profit will be $145,350-$144,250 = $1,100.
Now, let’s look at a long-range strategy.
Let’s say you believe that the Swiss Franc (CHF) is going to strengthen relative to the Japanese Yen (JPY) over the next two months.
In order to minimize risk, though, you decide to take a smaller position and put up 10,000 Yen against the Franc. Your broker gives you a quote of CHF/JPY = 98.35
Now, in order to pull of this long-range trade, you have to use a strategy called ‘margin trading’ and employ a tactic called “swapping”.
This is because Forex is, on a day-to-day basis, a ‘spot trading’ market, and the only way to carry a margin position forward long-term is to perform a ‘swap’. A swap is a method of buying and selling a currency pair at the same time on two different dates.
In this case, you will swap CHF/JPY at the time of your first trade, and set your position forward for two months (the amount of time you expect it to take for the Franc to rise against the Yen).
So, you agree to sell 10,000 JPY for CHF at 98.351, then swap your position for two months at a forward rate of CHF 98.45 – i.e. – buy CHF for 984,500.
Within a month, the exchange rate has moved upwards, and you must move your position forward another month by buying back Yen at a new rate of 97.40 for 970,400.
When the position closes at the two month mark, both trades are settled. Your JPY account is debited and credited 10,000 Yen simultaneously. Your CHF account is debited 970, 400 CHF and credited 984, 500 CHF — for a profit of 14,100 CHF.
Convert this back into JPY for a profit of 1,373,340 Yen.
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