Currency Trading Basics

All foreign exchange trades involve the simultaneous buying of one currency and the selling of another. Currency quotes are given as exchange rates; that is, the value or price of one currency relative to another. The relative supply and demand of both currencies will determine the value of the exchange rate.

When a currency trader places a trade, he wants the currency purchased to appreciate in value versus the one sold. His ability to determine the direction that the exchange rate will move, will dictate his gain or loss in the transaction. Let's do an example with a quote obtained from the MT4 platform.

example of a currency trade

Hypothetical Example of a Trade

The current bid-ask price for EURUSD (see image above) is 1.3488/1.3490, meaning you can buy 1 euro (EUR) for 1.3490 US dollars (USD). If you need help understanding how to interpret quotes, click on this link.

Suppose you feel that the Euro is undervalued against the US Dollar. To execute this strategy, you would buy Euros (simultaneously selling Dollars) and then wait for the exchange rate to rise.

So you make the trade: purchasing 100,000 EUR (1 standard Lot) and selling 134,900 Dollars. (Remember, at 1% margin, your initial margin deposit would be 1,000 Euros. In this example, we assumed that the leverage was 100 to 1 and that one standard lot was transacted. When you open a real account, you will instead have available up to a maximum of 500 to 1 leverage (0.2% margin), as well be able to trade mini (10,000-unit) and micro (1,000-unit) lots as well).

As you expected, EURUSD rises to 1.3590/1.3592. Since you bought Euros and sold Dollars in your previous trade, you must now sell Euros for Dollars to realize any profit. You can now sell 1 EUR for 1.3590 Dollars. When you sell the 100,000 Euros at the current EUR/USD rate of 1.3590, you will receive 135,900 USD.

Since you originally Sold (Paid) 134,900 USD, your profit is US $1000 (Please Note: if the price of the Euro against the US Dollar would have gone down instead of up by the same amount in the example above, there would have been a loss of $1000 instead of a profit. A possibility for profit is always accompanied by a risk of loss).

Total Profit = US $1000.00