How do you make money in forex?

I was surfing some forex forums lately, and noticed that some people are a bit confused by the idea of margin.

Forex contracts are traded in 100,000 increments. This can be in US dollars, Pounds, Euros, Australian dollars. It all depends on the currency pair you're trading. (You can also trade in 10,000 increments with some companies.)

All pairs are quoted with a "/". So EUR/USD is the Euro and the US dollar. The currency on the left is the base currency, and the one on the right of the "/" is the one being quoted.

So USD/CDN 1.3569 basically says that 1 US dollar "costs" $1.3569 Canadian dollars.

So if I think that the value of the USD will rise, I can put in an order to buy the USD at 1.3569. If it rises to say 1.3599, I can sell it, for a 0.0030 gain, or 30 "pips".

Now if forex were like stocks, and you needed to invest dollar for dollar, a 0.0030 on 2,000 would be a $6 gain. Nothing to get excited about.

But as I mentioned before, forex trading isn't on a dollar for dollar basis, it's based on contracts of 100,000 .

This is where the magic of leverage
comes into the equation.

Since forex allows you to get up to 100:1 margin. What this means is that you can control a $100,000 contract for every $1000 you have.

So going back to the previous example, that 30 pip gain would be translate into $300. A quick return on investment calculation gives us a 30% return on the $1000 initially put up. And it's not uncommon for 30 pip moves to occur throughout a trading day.

Now I know what you're thinking. If I can make a 30 pip gain, I can also make a 30 pip loss. This is true, but with the effective use of stop orders, you can almost guarantee to be out of trades going against you, at the prices you specify. You see unlike the stock and futures market, the liquidity and instantaneous execution of trades, allow most forex brokers to guarantee stop orders.

Limited Risk

And to top it off, unlike futures trading, where it's possible to lose all your money and more, in forex trading, if your funds fall below margin requirements, your positions are closed out. So even if you are dead wrong and there is a catastrophic market move against you, you can never lose more than the amount of money you have in your account.

This leverage, combined with the limited loss factor is what makes forex one of the most popular trading instruments now available.

In our next article we'll begin looking at some strategies for trading the forex markets.

Continued success!

Ray Chong
Ray Chong

P.S. If you're wondering how to get started in trading forex, but don't know where to start, my friend Mark McRae (who is a forex trader) has just released a new book. He walks you through the basics, introduces you to his trading system and includes lots of examples to get you on your way.

He not only guides you on which currencies to focus on, he illustrates a simple way to incorporate trends, Fibonacci and price targets to help you focus on winning trades to an awesome degree. If you're at all interested, please visit his site at: http://www.market-millions.com/ez/go.php?sforex.php he can tell you much more about it than I can.

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