Chapter 9. Forex and Exchange

The purpose of working in Forex is to make money from speculating with currencies. So far we have talked a lot about the currency market. But such questions as what initial capital is needed to work on Forex and what profit you can expect when working on Forex have not been considered so far. In this chapter we will try to clarify them.

Since currency exchange in an exchange office is a kind of simplified model of earning money on Forex, we will start with its consideration. Theoretically, you can profit from buying/selling currencies in an exchange office, but (as we will see in the course of reading the chapter) the amount of such profit is negligible compared to the possibilities of making money on Forex via the Internet.

So, let’s imagine that we have 1,000 US dollars and we want to make money on currency speculation at an exchange office. Let’s imagine that the USD/JPY exchange rate at the exchange office is USD/JPY 104.15/106.65. We forecast that the Japanese Yen will appreciate against the US dollar, so we decide to buy Japanese Yen with all the dollars we have. From the previous chapters we know that buy/sell rates refer to the base currency of the quote, i.e. in our case the US dollar. In this formulation, we sell dollars and the exchange office buys them. The buy (bid) rate is listed first in the quote, so we get 104.15 * 1,000 = 104,150 Japanese Yen.

If we now sell our Japanese Yen back for U.S. dollars, we will get 104,150 / 106.65 = 976.56 dollars according to the quote. That is, on such an operation we will suffer losses, and their size will be 1 000 – 976.65 = 23.35 dollars. What do we need to make a profit? Obviously, we need the selling price in the USD/JPY quote to fall below the initial buying price, i.e. the selling price must fall by more than 250 pips. Note that 250 is the size of the spread in the quote, meaning that the sell price must change by at least the spread amount in order for us to at least get our $1,000 back. The problem is that we can wait for the exchange rate to change by 250 pips for quite a long time (weeks and months) depending on the current state of affairs on Forex. But let’s imagine that the exchange rate has changed by as much as 500 pips in the direction we want, i.e. USD/JPY 99.15/101.65. What profit will we get by selling our Japanese Yen? We will get 104,150 / 101.65 = 1,024.59 USD. Our net profit from the transaction will be 1 024.59 – 1 000 = 24.59 USD.

In practice, you can wait a very long time for the exchange rate to change by as much as 500 points. That is, 24.59 US dollars can become our monthly or even quarterly income. Naturally, this is not the profit we would like to make. But you can be calm, because that is not the case with Forex trading!

From the previous example we have learned one important lesson – the smaller the spread in the quote offered to you, the more favorable it is for you as a trader. In exchange offices, the spread can be hundreds of points, and the quote itself is updated, as a rule, only once a day. At Forex, the size of the spread depends on the party that gives you the quote. For a private investor working in the Internet, the spread size is set by his Internet broker (commission house). Therefore, it is advisable to choose an Internet broker offering more favorable working conditions. Depending on the traded currencies, the spread size, as a rule, varies from 1 to 10 points. But, as it was mentioned earlier, in periods of instability of the currency market there is a practice of increasing the spread size by Internet brokers, and you should not forget about it.

Another lesson we learned from the previous example is that in order to make money from speculating on currency exchange rates at an exchange office, it is necessary to buy currency so that at the right moment to make the reverse operation, i.e. to sell it. And in the example with the exchange office, in order to buy Japanese Yen for U.S. dollars, we need to have the necessary amount of dollars on hand. Of course, it is obvious, but on Forex things are a bit simpler, and this will be discussed further. Another thing to pay attention to in the case of an exchange office is that for currency speculation we use only the money we have on hand. Of course, no one prevents us from going and taking a loan from the bank, but no bank will give you a loan for speculation on the currency exchange, and would you like to lose a large part of the loan on such speculations and get into debt? With Forex things are easier again. Using the principle of margin trading, which will be discussed in the next chapter, we can, possessing a relatively small capital (even a few thousand dollars), control the capital hundreds of times more than the money we have. The more capital we control, the more we can earn. After all, if we bought Japanese Yen not for 1,000 USD, but, say, for 100,000 USD, we would earn not 24.59, but as much as 2459 USD, and it is already worth it to continue studying Forex, isn’t it? So, let’s finish considering the example with the exchange office and move directly to the Forex currency market.

In order to work on Forex via the Internet, you must choose an Internet broker (hereinafter for convenience we will call it just a broker). Your broker opens an account for you into which you must transfer a certain amount of money, called a security deposit. The size of the security deposit is a philosophical and practical question at the same time. It all depends on how aggressively you are going to trade, what size of leverage (we will talk about it in the next chapter) you use, how many lots (we will talk about them a little later) you open simultaneously, what experience you have in Forex trading, etc. For a beginner trader, it is recommended to have at least 1,500 – 2,000 dollars on a security deposit. The security deposit is usually kept in special multi-currency accounts, which your broker opens for you in the bank it serves. As a rule, most Internet brokers are foreign companies registered in offshore zones. Therefore, accounts are opened in US dollars, but this (unlike the example with the exchange office) does not mean that you will be able to work only with dollar quotes. In order to buy Japanese Yen for English pounds sterling, a trader does not have to have the latter on his account. This is the advantage of the Forex market – you can earn on the difference in exchange rates without real delivery of currency, that is, the value date as such loses its meaning. Having US dollars on the security deposit, we can make transactions with any other currency. Let’s remember the example with the exchange office, where we expected the growth of the Japanese Yen to the US dollar or in other words the fall of the dollar to Yen in the USD/JPY quote. What if we expected the dollar to rise against the Yen on the contrary? It would be logical to buy U.S. dollars for Japanese Yen, but what if we have only 1,000 dollars and no Yen? Obviously, we would not be able to make such a transaction in an exchange office. But when working on Forex via the Internet, a trader can make such transactions, because there is no real delivery of currency (as we have already said) – the money is earned solely on speculation, and the profit is converted into the currency of the security deposit account, i.e. into U.S. dollars.

But the principle of earning remains the same – to make a transaction, we need to first buy the currency cheaper in order to sell it more expensive. Or first sell the currency more expensive to buy it cheaper, which is basically the same thing. After all, one currency is always bought or sold for another currency. The first stage of a Forex transaction is called opening a position. The second stage is called closing a position. At the moment of position closing the profit or loss from the transaction is calculated and either credited or written off from the security deposit. You can open a position either by buying or selling the base currency of the quote. If you open a position by buying a currency, this position is called a long position (long). If you open a position by selling a currency, the position is called a short position. When, for example, they say that “I have opened a long position of the U.S. dollar against the Japanese Yen”, they mean that in anticipation of an increase in the U.S. dollar exchange rate against the Japanese Yen, a certain amount of dollars was purchased for Yen.

The minimum size of a Forex trade is called a lot. Its size is expressed in the quoted currency, but, as a rule, it is equivalent to 100 000 US dollars. When you work in the currency market, you open and close positions, the size of which is always equal to a whole number of lots. The question you probably have now is how can a private investor work on Forex when the minimum transaction amount is so large? Don’t be frightened, the principle of margin trading, which will be discussed in the next chapter, allows you to manage a capital of $100,000 with only a few thousand dollars on your security deposit and risking only your security deposit.

But even the principle of margin trading does not save those who do not have such an amount. After all, someone has a relatively small free capital (about a thousand dollars), but would also like to work on Forex. For such investors Internet brokers have introduced the concept of mini lot, which is equivalent to 10 000 US dollars and can be easily controlled by a security deposit of one thousand dollars. Some brokers even offer micro lots (micro lot), the size of which is equivalent to only 1 000 US dollars, and to control it is enough just a few hundred dollars, however, such lots are used much less often. In practice, you, as a novice Internet trader, will most likely work with mini lots.

It should be noted that the larger your security deposit is, the more lots you will be able to keep open on Forex at the same time. After all, depending on the strategy, which each trader develops for himself, you may need several open positions at the same time – this should be taken into account when trading. Therefore, always control the size of your security deposit.

What is the approximate income that can be obtained from a single Forex trade? Imagine that we are working with mini lots, with a security deposit of 1,000 USD, and we forecast the growth of the US dollar against the Japanese Yen at the current rate of USD/JPY 104.75/80. As we can see, the spread size is only 5 pips, which is typical for Forex and much smaller than in the example with an exchange office. Let’s imagine that we open a long position on the US dollar with one mini lot at the rate of 104.80 Japanese Yen per dollar. Our forecast of the rate movement comes true, and at the moment of closing the position the dollar/yen rate is USD/JPY 105.10/15. Thus, we managed to “catch” a favorable rate movement of 105.10 – 104.80 = 30 pips. It should be taken into account that the points correspond to the quoted currency, i.e. Japanese Yen. In order to calculate the size of our profit in US dollars it is necessary to convert 30 points into the dollar equivalent and multiply it by the mini lot size of 10 000. To convert the points into dollar equivalent, we divide 0.30 by the selling rate of the US dollar for Japanese Yen, i.e. 0.30 / 105.15 = 0.0029. The received value corresponds to 29 points in dollar equivalent and multiplying it by 10 000, we get the size of our profit – 29 US dollars. It is worth noting that the movement of rates in our example occurred only by 30 points, and on such movement we managed to make a profit of 29 dollars on the available 1 000 US dollars. In practice, such a movement can be “caught” on Forex in a few hours or even minutes.

To summarize the chapter, let’s compare the profits obtained from the exchange office operation described at the beginning of the chapter and the Forex operation described at the end of the chapter. Obviously, the opportunities offered by forex do not compare favorably with an exchange house. Profits that can theoretically be earned in a month at an exchange office can be earned in one hour at Forex! Continue to study the material of Forex Arena site and soon you will learn how to make your work on Forex bring you a stable income.
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