Currency speculation: a business with relations
In a currency transaction, market participants acquire one currency “against the other”. To put it simply, a loan is taken out in one currency, which is then exchanged for the other currency. A case study:
On the Forex market, 1 euro is traded at $1.30. That means $1.3 is paid for 1 euro. Conversely, just under 77 cents are paid for one dollar. An investor who expects the euro to fall against the US dollar borrows EUR 1 million and exchanges it for USD 1.3 million. The investor is right in his assessment and a day later the price for a euro is only $1.28. He, therefore, exchanges $1.28 million for 1 million euros and repays the loan taken out in euros in full.
The profit in this business is the remaining dollar balance and is $20,000. The interest of around 100 euros must be deducted from this profit, which accrues overnight for the loan in euros.
Forex: profits in every market situation
The particular attraction of currency trading in its current form is the ability to conduct business in the above sizes with small and medium-sized accounts. With Forex Trading, the credit in one currency is offset against the balance in the other currency.
As a result, only a fraction of a market position that has been entered actually has to be raised. This “margin” serves as security and, depending on the broker and currency pair is between 0.25 and 2 percent of the market value.
- Move EUR 4 million in the market with EUR 10,000
- Great leverage offers huge profit potential
This means that with an account balance of 10,000 euros, positions equivalent to up to 4 million euros can be moved. In a typical Forex business, 1 percent of the market value of a position is deposited as a margin.
The low capital investment not only makes trading on the Forex market affordable for many investors but also brings with it a very large leverage effect: If only a fraction of a position is actually covered by equity, small market movements are already sufficient for very large profits (or losses). With a 100-fold leverage effect, for example, a market movement of 1 percent is sufficient to double the capital employed (100 percent profit) or to use it up completely (total loss).