A Forex deal is a contract agreed upon between the trader and the market maker (i.e. the Trading Platform). The contract is comprised of the following components:
Timeframe can also be a factor but we will only focus on “Day” or “Spot” trading where deals have a lifespan of no more than one full day. It should be noted however, that deals can be renewed (“rolled-over”) to the next day for a limited time.
Since currencies are traded in pairs, let’s assume that a trader is interested in the AUD/USD. On a certain day the exchange rate is 1.0400 (this is referred to as the “spot” rate). Therefore if a trader has bought 1000 AUD he has paid 1,040 USD. If the spot rate then rises to 1.0550, the trader could now sell the 1000 AUD and receive 1,055 USD. He or she has therefore made a profit of 15 USD. Although the trader has obtained a profit, this profit is small unless you take leverage into account.
Leverage or Margin trading allows traders to use credit (a trade purchased on margin) to maximise returns (and losses). Collateral for the “loan/leverage” in the margined account is provided by the initial deposit. This can create the opportunity to control 100,000 AUD for as little as 1000 AUD (leverage is generally provided at 100:1 although this can be tailored to the client’s wishes). When using leverage, the trader should ensure that a stop loss is in place so that his exposure is no more then the initial deposit outlaid.
So to use the example above and by using leverage, the trader could now buy 100,000 AUD at a cost of 104,000 USD (his or her outlay is actually 1,040 USD; remember leverage of 100:1). If the spot rate then rises to 1.0550, the trader can sell the 100,000 AUD and receive 105,500 USD, equivalent to a profit of 1500 USD. It is important to note that the amounts mentioned as deposits are not necessarily the minimum required in order to trade. Depending on the platform utilised, client can have minimum margin requirements for as little as 25 AUD.
As mentioned above, another point for new traders to consider is their stop loss rate. This is the currency exchange rate at which the deal would automatically close in the event the market ran counter to the trader’s forecast. On most trading platforms, this will result in the loss of the trader’s deposit only and no further monies will owed.
A trader can also change his stop loss at any time while the deal is open. If the trader changes the stop loss downwards (in a case where the position is losing and is now near the automatic closing) then additional funds will be required as margin. If the trader changes the stop loss upward (in a case where the deal will already see a profit) then the trader can decrease his original deposit and the difference will be credited.
Robert Francis, General Manager, Easy-Forex
Disclaimers: The views expressed in this article are those of Robert Francis, a representative of Easy-Forex and is not intended as general advice. This does not constitute a recommendation nor does it take into account your investment objectives, financial situation nor particular needs.