Business

Placing a trade in the forex market is basically the same as placing a trade in any other market. Some people get confused because they feel they are not buying or selling anything like in the stock market, were you buy or sell part of a company.

We will dissect a trade from beginning to end in order to understand what is being done in the process.

Step 1: The trader has USD 10,000 in his forex broker account.

Step 2: In the morning the GBP/USD quote is 1.7478. This means that every GBP (Great British Pound) is worth 1.7478 dollars (i.e. 1:1.7478). Based on his analysis, the trader thinks that within the next 24 hours the GBP will gain strength against the US Dollar (i.e. a single GBP will exchange for more dollars). The trader wants to profit from the speculated move.

Step 3: The trader places a BUY GBP 100,000 (remember,
although the trader does not have that amount of money in the account, trading on margin will allow this transaction) order with his broker either through the phone or through the broker’s on-line trading platform. At this moment the trader has purchased GBP 100,000 at a cost of 1.7478 USD per GBP. In effect, what has also happened is that the trader sold USD 174,780.

Step 4: About 12 hours after placing the trade, things turned out as the trader has speculated and the GBP has appreciated in value against the USD and the quote is 1.7578, a difference of 0.0100 (or 100 pips) from the quote 12 hours ago. The trader decides to liquidate the position with the current profit.

Step 5: In order to close the position the trader has to now SELL the GBP’s he bought earlier and buy back USD. An order to sell GBP 100,000 is placed.

Outcome: The market moved into the direction the trader speculated and a 100 pip profit was achieved. The profit is calculated in the following manner:
Trade Open (rate 1.7478) GBP +100,000 USD -174,780
Trade Close (rate 1.7578) GBP -100,000 USD +175,780
Profit: USD +1,000

Important!
Here we saw a trade from beginning to end with a final outcome of a USD 1,000 profit or a return of 10% on the trader’s equity. By now you obviously understood why it was possible to make a 10% profit in less than one day, we traded on margin. Remember how we mentioned above that using leverage can bring you incredible profits (like in our example)? Well, what if instead of the price going up 100 pips it would have gone down 100 pips to 1.7378? That would have been a loss of 10% of the trader’s total equity.

Bottom line, and as already mentioned above, leverage can bring you big profits but it can also bring you big losses if not used properly. Again, this issue is of extreme importance and will be dealt with in the “money management” section of the course.