How is Money made by Trading Forex?

Trading Forex is no different from trading any other speculative market in terms of the basic concept of buying and selling. In forex market, trading is done by using one currency against another currency. The simple objective of trading in the forex market is that we trade a currency pair to profit from the stronger currency against the weaker currency. All Currency pairs are unique and have different prices, which keeps on fluctuating, as per the demand and supply in the forex market. In simple words, if we speculate any two currencies, one is stronger another is weaker as so we will buy or “Go Long” with the stronger currency and/or sell or “Go Short” with the weaker currency in any particular currency pair.

What is a Forex Currency Pair Price Quote and How do you read it?

Forex market is all about foreign exchange monetary transactions. The price of any currency is always quoted in a currency pair because whenever we are buying a currency at the same time we are simultaneously selling another currency. Let’s see an example of a currency pair price quote between Euro and United States Dollar
EUR/USD = 1.2345

Now let’s understand how we read a currency pair price quote. In the above mentioned EUR/USD currency pair, Euro is the “Base Currency” and U.S. Dollar is the “Quote or Counter Currency”.

When we buy this currency pair, it means that we are buying the “Base Currency” i.e. Euro and selling the “Quote or Counter Currency” which is U.S. Dollars. If we want to buy 1 Euro, we will have to pay the amount of 1.2345 U.S. Dollars.

When we sell this currency pair, it means that we are selling the “Base Currency” i.e. Euro and buying the “Quote or Counter Currency” which is U.S. Dollars. If we sell 1 Euro, we will receive the amount of 1.2345 U.S. Dollars.

Understanding in a very clear and simple way, in any currency pair price quote the first currency i.e. “Base Currency” is the basis for buying or selling. If we are buying a particular currency pair, then “Receiving Base Currency, Paying Counter Currency” and if we are selling a particular currency pair, then “Selling Base Currency, Receiving Counter Currency”

Entering a Trade either ways i.e. Buying “Going Long” or Selling “Sell Short”

As soon as we analyze the current market position and/or as per our charting analysis, we come to a decision that whether we want to buy a particular currency or sell a particular currency. In forex trading, for buying a currency, we call it “Long” “Go Long” and for selling a currency, we call it “Short” or “Go Short”. In Stock market, we cannot sell a particular stock and keep it as a position in our portfolio, but in forex market, we have an advantage, we can trade either ways i.e. we can sell any currency and buy it later, whenever we desire to close the position or book a profit at our desired price level.

Why there is a difference between the Buy and Sell Price of a Currency Pair?

The Difference between Bid & Ask Price is called Spread.

In Forex Trading, currency price is always quoted with two prices i.e. one is “Bid Price” or “Sell Price” and another is “Ask Price” or “Buy Price”. The “Bid Price” is always lower than the “Ask Price”. The bid price means, it is the price at which we sell the currency pair, or in other words, it is the price in which the opponent is interested in buying the currency pair. The ask price means; it is the price at which we buy the currency pair, or in other words, it is the price in which the opponent is interested in selling the currency pair.

The difference between the bid and ask price is called the “Spread”. Trading in forex market is free of commissions; Spread is the only transaction cost which we pay. The spread varies among all the forex currency pairs and also among all forex brokers.

How is Profit made by Trading Forex?

For better understanding as how profit is made? We will use the above EUR/USD daily chart, in the early of August 2012, a speculation was made that if the price breaks the upper price level of 1.2443, then the Euro might advance and start trending upwards as so a buy stop order was placed a couple of pips above the 1.2443 price level. The buy stop order was placed @ 1.2450. In the mid of August 2012, the price level of 1.2443 was broken with a strong breakout and as so the order was executed.

In the mid of September 2012, EUR/USD made a fresh low of 1.2802 and started to advance again, but according to the trader’s trading strategy rule, he has to exit his trade and book profits if the currency pair declines again at this price level because a decline at this price level means that the uptrend is losing its strength. In the early November 2012, the stop loss got hit, and the trader booked a profit of 350 Pips. The Pip value of EUR/USD currency pair is $10 per standard lot, which means the total profit made per standard lot is 350 pips x $10 = $3,500. There are many types of trading strategies and different timeframes, which trader follows according to his trading goals and money management. Mostly every trader creates his own unique style of trading strategy. We will learn in the later lessons, what are the different types trading strategies and how to trade with different and/or multiple timeframes?

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