Foreign Exchange Example

Forex trading is the simultaneous buying of one currency and selling of another. Currencies are quoted in pairs eg US Dollar vs. Japanese Yen. When one currency increases in value it means it strengthens against another and the value of the other decreases. The best way to explain how Forex trading works is through an example, but before we get started, read these quick definitions that will be helpful in the example.

Margin – the fractional amount of the trade value required as a deposit.

See our jargon buster section later on for more information.

• The US dollar is trading against the Japanese Yen at 117.00/02, which means 1 US dollar will purchase 117.00 Yen or it will cost 117.02 Yen to purchase 1 US dollar.
• You decide to purchase 10,000 US dollars at 117.02. The trade size is $10,000 US dollars. However, for currency trades the margin requirement is only 1%, so you only need to allocate $100 towards this trade.
• Two days later, the price of US dollars has risen and the exchange rate is now 117.65/67. You decide to close your trade by selling your US dollars for 117.65 Yen each.
• You will receive: $10,000 (size of position) x [117.65 (sell price) – 117.02 (buy price)] = 6,300 Japanese Yen. To convert this back into dollars: 6,300 divided by 117.65 = $53.55 US dollars.

Note that since you held this position overnight a financing fee will be charged, which is equal to the difference in interest rates between the two currencies.

If instead of rising the price of US dollars had fallen by an equal amount, then you would have lost $53.55, plus financing fees.