Buying and Selling Currencies
Trading opportunities in the forex market deserve serious consideration as a diversification strategy for your portfolio.
While online equities and futures trading have enjoyed exponential growth and widespread notoriety over the past few years, online foreign exchange trading is only now gaining popularity among seasoned active traders, commodity trading advisors (CTAs), and other professional money managers.
Until recently, large international banks dominated the foreign exchange market, only allowing access via telephone trading to a select few such as Fortune 1000 companies, large funds, high-net worth individuals, and so on. But now, the tide has turned and finally there are established online trading firms that provide individual investors with direct access to the largest, most liquid financial market in the world.
In this market you may buy or sell currencies. The objective is to earn a profit from your position. Placing a trade in the foreign exchange market is simple: the mechanics of a trade are virtually identical to those found in other markets, so the transition for many traders is often seamless.
Here are an example of how forex trading works. Say, a trader purchases 10,000 euros in the beginning of 2004 at the EUR/USD rate was .9600. In May of 2006 the trader exchanges his 10,000 euro back into US dollar at the market rate of 1.1800. In this example, the trader earned a gross profit of $2,200.
Currencies are quoted in pairs, such as EUR/USD or USD/JPY. The first listed currency is known as the base currency, while the second is called the counter or quote currency. The base currency is the ‘basis’ for the buy or the sell. For example, if you BUY EUR/USD you have bought euros (simultaneously sold dollars). You would do so in expectation that the euro will appreciate (go up) relative to the US dollar.
EUR/USD
In this example euro is the base currency and thus the ‘basis’ for the buy/sell. If you believe that the US economy will continue to weaken and this will hurt the US dollar, you would execute a BUY EUR/USD order. By doing so you have bought euros in the expectation that they will appreciate versus the US dollar. If you believe that the US economy is strong and the euro will weaken against the US dollar you would execute a SELL EUR/USD order. By doing so you have sold euros in the expectation that they will depreciate versus the US dollar.
GBP/USD
In this example the GBP is the base currency and thus the ‘basis’ for the buy/sell. By doing so you have bought pounds in the expectation that they will appreciate versus the US dollar. If you believe the British are going to adopt the euro and this will weaken pounds as they devalue their currency in anticipation of the merge, you would execute a SELL GBP/USD order. By doing so you have sold pounds in the expectation that they will depreciate against the US dollar.
USD/JPY
In this example the US dollar is the base currency and thus the ‘basis’ for the buy/sell. If you think that the Japanese government is going to weaken the yen in order to help its export industry, you would execute a BUY USD/JPY order. By doing so you have bought U.S dollars in the expectation that they will appreciate versus the Japanese yen. If you believe that Japanese investors are pulling money out of U.S. financial markets and repatriating funds back to Japan, and this will hurt the US dollar, you would execute a SELL USD/JPY order. By doing so you have sold U.S dollars in the expectation that they will depreciate against the Japanese yen.
USD/CHF
In this example the CHF is the base currency and thus the ‘basis’ for the buy/sell. If you think the Swiss franc is overvalued, you would execute a BUY USD/CHF order. By doing so you have bought US dollars in the expectation that they will appreciate versus the Swiss Franc. If you believe that due to instability in the Middle East and in U.S. financial markets the dollar will continue to weaken, you would execute a SELL USD/CHF order. By doing so you have sold US dollars in the expectation that they will depreciate against the Swiss franc.
Martin Chandra (forex-trading-tutorial.com) is a full-time investor. He has been researching investment strategies and make his own living. Learn more at forex-trading-tutorial.com
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