Lesson 3 – How Can One Earn in Forex?

 

All Forex transactions are based on margin trading principles. What does that mean? Each trader who wants to trade on the Forex market has his/her own deposit (capital), i.e. a certain sum of money that he/she brings as a deposit. The essence of the principle is that a broker lets the trader work with the amount of capital that exceeds the deposit’s size. In addition, the income can be equivalent to the deposit even if an exchange rate is going to change marginally. This is where the secret to earning money fast is hidden, and Forex is attractive because even if you do not have huge capital, you can still earn a lot of money.

Let us examine this in more detail. The margin trading principle is that a broker provides the traders with leverage. A trader deposits a sum of money into a chosen broker’s account. The deposit determines the maximum capital with which a trader can open—it must be no bigger than a certain percentage of the deposit. Before opening a trade, the broker examines how big the trade that we want to open is compared to our deposit. If it is within the frame of the broker’s leverage, the broker automatically allocates their funds. In this case, a deposit is accepted.

Let’s say a trader’s deposit is 1,000 USD. The opened trade is bought for 40,000 (0.4 lot size. Lot size is simply the size of the trade amount. A standard lot represents 100,000 units of any currency) USD against a Japanese yen. If a broker has provided a leverage of 1:100, the leverage will be equal to 1,000:40,000 = 1:40, it means that we do not exceed leverage; therefore, a broker will help us make a transaction. We can also open trade that fluctuate from 1,000 to 100,000 USD (or from 0.01 to 1.0 lot size) with a leverage from 1:1 to 1:100.

When a trader opens a trade, he guarantees it with the deposit that he has brought. If a transaction is unsuccessful, and a position closes with a loss, the trader will lose part of the funds that the broker provided; however, the broker would automatically compensate these funds from the trader’s deposit. If trading is going to be unprofitable, the deposit will be lower. When your deposit is empty, you can no longer open trades. We see that a trader is risking his own money—he is not going to become a broker’s debtor. This is a very important, positive characteristic of Forex. For example, if you are trading options on the stock market (an option of transaction) and are unsuccessful, your losses can be bigger than your deposit.

And if a Forex trade is successful the situation is different as well. First, your deposit would be returned to you; second, the profit would immediately go to your account after a transaction. In this way, the deposit is growing. A trader can leave a profit in the account for further trading or withdraw the profit from the account. If a trader leaves the profit in the account, possible transaction sizes are increasing; therefore, profits will increase as well.

Let’s investigate one more example related to leverage.

Our deposit is equal to 1,500 USD, and we have decided not to use leverage—we will use only our own funds. Having analyzed the market situation, we buy 1,000 EUR. For example, we buy EUR/USD at 1.33000. We expect that the euro will increase in value. Let’s say we were right, and the euro increased in value by 1% in relation to the USD. In other words, the currency pair EUR/USD increased by 100 points so that now the EUR/USD exchange rate is 1.34000. When we decide to close this position, we sell EUR. In this case, our profit will make 10 USD (134000 – 133000 = 10). Not a lot of money, but still a profit. Some will say that it is not worth risking this transaction because of such a low profit; they may recommend to wait for an appropriate moment to open a position and to close it later. However, if we used leverage, we could buy open a bigger position. If the leverage is 1:100, our transaction would be 100 times bigger,  and our profit would be 1,000 USD. If we were using a leverage of 1:10, our profit would be 100 USD.

It is worth mentioning that EUR/USD  usually moves by 100 points or more; therefore, when you master a trading strategy, and when you know how to manage risks, your profit can be quite significant even if the leverage is small.

When the leverage changes, our trading effectiveness changes as well.

While we are talking about the possibility of earning higher profits, we must not forget that if a transaction is unsuccessful, we risk losing money. If a trader does not place a Stop Loss order (an order that limits losses), and the leverage is 1:100, he/she could lose the whole deposit if the exchange rate changes by 100 points the opposite way of what he/she expected. Therefore, it is critical to learn Money Management (MM). Even more important: follow, and do not violate Money Management rules. When you learn Money Management, and you will never lose your money.

Please read the following posts:

• The whole truth about leverage in Forex
• Money Management in Forex

Exercises

1. Imagine that you opened a trading account and deposited 1,000 USD. The maximum leverage that your broker provides is 1:100. Can you open EUR/USD position to the extent of 30,000 EUR (0.3 lot size)? 70,000 EUR (0.7 lot size)? 120,000 EUR (1.2 lot size)?

2. Let’s say your account is 1,000 USD. You already have opened a GBP/USD trade for 70,000 amount (0.7 lot size)  . In accordance with this trade size, you already have a profit of 100 USD. Can you open one more position for EUR/USD with 50,000 EUR (0.5 lot size)?

I wish you success!

Do you have any questions? Please write your questions in the comments section—we will do our best to solve them with you!