February 10, 2017
Making consistent profits is one of the hard tasks that every forex trader encounters in their early trading career. Let’s discuss how traders actually make profit in this market.
Imagine that the EUR/USD pair is trading at 1.0950 in the forex market, which means if you sell 1 euro you will get 1.0950 USD in return. Since the price of currencies always fluctuates, a trader’s goal is to anticipate the market movement and make money. For instance, if you think that the price of the euro will go up, then and you would open a long position on EUR/USD. If the next day the currency pair trades at 1.1000, by closing the long position you would make 50 pips in profit. What a pip is and how to calculate the dollar value of pips will be discussed later.
By using concepts like trading on margin and leverage, you could open a much larger position than the size of your trading account. Compared to your investment, the profit potential is extremely high in this industry, but beware. that using a higher leverage also increases the risk of losses.
Currencies are always traded in pairs. A currency pair consists of the base currency, and the quote (or counter) currency. Let’s explain this with an example:
The USD/JPY is trading at 110.20. This is a classic example of forex quotes. The base currency is on left-hand side of the slash, in this case the U.S. dollar, while on the right-hand side you will find the counter currency, Japanese yen. This means for 1 USD (base currency) you are going to get 110.20 Japanese yen in the foreign exchange market. (You probably also noted that most of the time the short names of the currencies are used to express their quotes.)
In order to make a profit, traders buy or sell certain currency pairs. To make a profit from the market volatility, traders have to successfully anticipate the market’s next movement. To do so, traders have various tools at their disposal, the most important of which are fundamental and technical analysis. The characteristics of both fundamental and technical analysis will be covered later.
If your analysis shows that the price of EUR/USD pair will go up, then you would open a long position. On the contrary, if your analysis suggests that the price of EUR/USD will go down then you would open a short position.
Bid and Ask Price
The bid and ask prices are prices at which the market buys the currency from you (bid price), and sells the currency to you (ask price). Let’s show this with an example:
EUR/USD is trading at 1.0950/53. The bid price, or price at which the market buys one euro from you, is $1.0950. The ask price, or price at which the market is willing to sell you a euro, is $1.0953. The following picture shows how bid and ask prices are usually presented by brokers.
Did you notice the gap between the Bid and Ask price? This is the spread charged by your broker. Competitive brokers will offer you tight spreads which will cut down your trading cost significantly. Spreads on majors are usually very low, just a few pips, but can increase significantly in times of higher volatility and important news announcements.