Forex and Exchange Office
Working at Forex is targeted to gaining money on currency speculations. We have been talking much about the currency market above. But such topics, as what beginning capital is needed for work at Forex, and what profit can be expected at Forex, have not been discussed yet. In this chapter we will try to make it clear.
As the currency exchange in the exchange office is a simplified model of yield at Forex, we will start with its description. Theoretically, profit can be gained from buying or selling currency in the exchange point, but (what we will become assured of in the process of reading the chapter) the profit sum is tiny, as compared to the opportunities of earnings at Forex and via the Internet.
So, fancy that you have 1000 USD and want to earn on currency speculations in the exchange office. Assume that the US dollar versus the Japanese yen is quoted at 104.15/106.65 in the exchange office. We forecast the increase of the Japanese Yen versus the US Dollar, and hence, decide to buy the Yen for all our dollars. From the preceding chapters we know, that the rates of ask and bid are related to the basic currency of the quote, in our case it is to the US dollar. Thus, we are selling the dollars, which are then bought by the exchange office. The rate of buying or bid, is shown first in the quote, thus we get 104.15 * 1 000 = 104 150 JPY.
If we sell our yens for the US dollars immediately, according to the given quote we will receive 104 150 / 106.65 = 976.56 USD. That means we will have losses at this operation, equal to 1000 – 976.65 = 23.35 USD. What is needed to get profit? It is obvious that we need the ask price in the quoting USD/JPY to fall lower, than the initial buy price, that is, the bid price should fall by more than 250 points. Note that 250 is the size of the quoting spread, that is, the ask price should change at least by the size of the spread, so that we could at least get back our 1000 USD. The problem is that we can wait long enough (weeks, months) for the change of the currency rate by 250 points, depending on the current situation at Forex. But fancy, that the rate after all has changed for 500 pips in the favorable for us direction; that means the quoting is USD/JPY 99.15/101.65. What profit will we gain after selling our Japanese yen? We will get 104 150 / 101.65 = 1 024.59 USD. Thus, our net profit from the operation will be 1 024.59 – 1 000 = 24.59 USD. In reality, one can wait too long for the currency rate to change by 500 points. That means, 24.59 USD can become our month or even quarter profit. Naturally, it is not the profit we would like to gain. But you can relax, as working at Forex is completely different!
From the previous example we learned the important information, that the lower is the spread volume of the offered quoting, the more profitable it is for traders. In the exchange points the spread can equal to hundreds of ticks, and the quoting, as a rule, is only changed once in 24 hours. At Forex, the size of the spread depends on the party, which sets the quoting. For a private investor, who is working in the Internet, the spread volume is set by his Internet broker (the brokerage house). Therefore, it is important to choose the Internet broker, which offers the most favorable working conditions. Depending on the currency pairs, the spread volume usually varies from 1 to 10 pips. But as it was stated above, when the currency market is instable, the Internet brokers can increase the spread volume, so we should not forget about this as well.
Another lesson, which we learnt from the previous example, is that for turning profit from currency rate speculations in the exchange point, it is necessary to buy currency in order to make a reverse operation in due time, that is to sell it. Besides, in the example with the exchange point, in order to buy the Japanese yen for the US dollars we need to have the whole sum in dollars. This is vivid, of course, but at Forex everything is easier, and this will be commented on further. One more thing, which we should pay attention to in case with the exchange point is, that for currency speculations we can use only the funds, which we have in cash. Of course, nobody prohibits us from taking a bank credit, but no bank will give you a credit for speculations on the currency exchange; moreover, you would not like to lose the most part of your credit on such speculations and get into debt, would you? With Forex, everything is easier. Using the principle of margin trading, which will be discussed in the next chapter, and having comparatively inconsiderable funds (even a few thousands of the US dollars), we can control the capital, which by hundred times exceeds our own funds. The bigger capital we manage, the higher can be the profit. If we bought the Japanese yen not for 1000 USD, but for, let us say, 100000 USD, we would gain not 24.59, but the entire 2459 USD, and this makes it worth to continue Forex education, doesn’t it? Hence, let us finish the discussion of the exchange point and pass to currency market Forex.
In order to work at Forex via the Internet, you should choose the Internet broker (we will call it simply “a broker” for convenience). The broker opens an account for you, in which you should deposit a certain sum of money, called the security deposit. The amount of the security deposit is a philosophical and, at the same time, a practical question. It depends on how aggressive you are going to trade, and on the leverage (it will be discussed in the next chapter), which you will be using, on how many lots (it will be discussed later) you are opening at the same time, and what experience of Forex trade you have etc. For a novice, it is recommended to have not less than 1500-2000 USD on the security deposit. The security deposit, as a rule, is kept on special multicurrency accounts, which the broker opens for you in the bank, where it is serviced. Generally, the majority of the Internet brokers are foreign corporations, registered off-shore. For this reason, the accounts are opened in the US dollars, but this (unlike in the example with an exchange point) does not mean, that you will be able to work only with the dollar quotes. To buy the Japanese yen for pounds, the Internet trader does not need to have pounds on his account. The advantage of Forex market is the possibility to earn on the currency rates without real currency supply, i.e. the date of the currencies valuation loses its significance. Having the US dollars on the security deposit, we can make deals on any other currency. Let us remind the example with the exchange point, where we were waiting for the growth of the Japanese yen rate versus the US dollar, in other words, for the falling of the dollar rate versus the yen in the quote USD/JPY. And what if we were on the contrary, waiting for the up-raise of the dollar rate vs. the yen? It would be more logical to buy the US dollars for the Japanese yen, but what should we do, if we have only 1000 USD and no yens? Naturally, we would not be able to make such operation in the exchange office. Thus, working at Forex via the Internet, a trader can make such deals, since there is no real support of the currency (as we have already mentioned), the money is gained only on speculations, and the profit is converted into the currency of the security deposit, i.e. into the US dollars.
But the principle of gaining is the same: to make an operation, we should at first buy the currency at a lower price in order to sell it at a higher price later on. Or first, sell the currency at a higher price, in order to buy it later at a lower price, which is almost the same. Because one type of the currency is always bought or sold for another type. The first operation stage at Forex is called the opening of the position. The second one is called the closure of the position. At the moment of the position closing, the profit or loss from the deal is calculated, which is either added to or misused from the security account correspondingly. You can open the deal by a buy- or a sell- order of the base quote currency. If you open the position by currency buying, such position is called the long position. If you open the position by currency selling, such position is called short. When, for instance, you hear a phrase “I have an open long position on the US dollar vs. the Japanese yen”, it is meant, and that waiting for the rise of the US dollar rate versus the Japanese yen, a purchase of a certain quantity of dollars for yens was made.
The minimal volume of the operation at Forex is called a lot. Its size is depicted in the quoted currency, but as a rule, is equal to 100 000 USD. Working at the currency market, you open and close positions, the size of which is always equal to a whole number of lots. The question, that may have arisen, is how a private investor can work at Forex, if the minimal sum of the deal is so high. Do not be scared, the principle of the margin trading, which will be discussed in the next chapter, will let you manage the funds equal to 100000 USD, having only some thousands of dollars on your security deposit and risking of your deposit only.
But even the margin trading principle cannot save those, who do not have such amounts. As someone can have a relatively small capital (around 1000 USD), but would like to work at Forex as well. For such investors, the Internet brokers introduce mini lots, which are equal to 10000 USD. And some brokers even offer micro lots, equal only to 1000 USD, and to control it, one needs only a few hundreds of dollars, but these lots are used rather rarely. In practice, being a novice Internet trader, you will most likely work with mini-lots.
It should be noted, that the higher your security deposit is, the more lots you can have, opened simultaneously at Forex. As depending on the strategy, which is worked out by every trader, you may need a number of simultaneously opened positions, and this should be taken into account at trade. Therefore, you should always control the amount of your security deposit.
What is the approximate profit from one operation at Forex? Imagine, that we are dwelling with mini lots, the security deposit amounts to 1000 USD; we are forecasting the increase of the US dollar rate versus the Japanese yen at the current quotation of USD/JPY 104.75/80. As we can see, the spread is equal to 5 points, which is typical of Forex and considerably less, than in the example with the exchange office. Fancy that we are opening a long position on the US dollars with one mini lot at the quotation of 104.80 JPY for one dollar. Our forecast of the rate movement confirms, and at the moment of the position closure the rate is USD/JPY 105.10/15. So, we have managed to “catch” the profitable for us rate movement equal to 105.10 – 104.80 = 30 ticks. It should be noted, that the ticks correspond to the quoted currency, i.e. the Japanese yen. In order to calculate the value of our profit in the US dollars, it is necessary to convert 30 ticks in the dollar equivalent and multiply by the size of the mini lot 10 000. To convert pips to the dollar equivalent we divide 0.30 by the rate of the US dollar selling for the Japanese yen that is 0.30 / 105.15 = 0.0029. The received value corresponds to 29 points in the dollar equivalent, and multiplying it by 10 000, we can receive the sum of our profit- 29 USD. The rate movement in our example was equal only to 30 ticks, and on this movement with 1000USD we have managed to get profit amounting to 29 USD. Actually, this movement can be “caught” at Forex within a few hours or even minutes.
To summarize the chapter, let us compare the profit, received from the operation in the exchange office, described at the beginning of the chapter and the operation at Forex, discussed at the end. It is evident, that the opportunities, which Forex provides, cannot be compared to those of the exchange office. The profit, which can theoretically be gained within a month in the exchange office, can be achieved within an hour at Forex!