How Is Money Made In Forex?

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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 as .25 percent. If I already have a funded account, that amount will be held aside for this trade — it cannot be used as a 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 the 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.

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