Exchanging Currencies vs. Trading Forex to Make Money

Read below the difference between using a bank or money transfer currency exchange company to exchange money for a one-off purchase, travel money or business transactions and using a forex broker to make money on the FX currency trading market.

Article by EARNFOREX.COM.

www.exchange-rates.com recommends www.earnforex.com if you are looking for reviews when choosing a Forex broker.

Forex Trading Article written by www.EarnForex.com

Exchanging Currencies vs. Trading Forex to Make Money

People exchange currencies for travel or business needs. A person does not seek any profit from a simple currency exchange. The prevailing exchange rate is applied along with regular commissions for the service provided by a currency exchange shop (or a bank's Forex department). However, trading currencies in the Forex (or FX) market will result in a profit or loss as explained below. Due to the numerous advantages it offers, more and more people across the world are opting for spot Forex trading. Here we look at the basics of Forex trading and how it differs from traditional exchange of currencies.

Exchanging and trading currencies

To exchange currencies, a person goes to an exchange office and physically hands over the currencies and gets the equivalent amount of the currency he needs based on the given exchange rate. Alternatively, it is all done electronically via some foreign exchange company and bank accounts. In both cases, the exchanger usually uses the previous day's closing exchange rate in the spot Forex market. Now, the same spot Forex market is where the speculative currency trading is done. Spot FX market is a decentralized market - trading does not take place in any physical location. It is an over-the-counter (OTC) market with no central exchange that processes the trades. A majority of transactions is done via the internet using special software - trading platforms. Now, the next obvious question that may arise in one's mind is where to get a trading platform and how to get connected to a price feed. This is where a retail Forex broker comes in.

Need for a Forex broker

When a person approaches an authorized money exchanger, it acts as a bridge between the owner of the currency and the bank. Likewise, to trade in the Forex market speculatively, an account should be opened with a Forex broker who will act as a bridge between a trader and a bank, which will serve as the counterparty to the trades. When someone is simply exchanging currencies, a commission is charged by an exchanger. In case of a Forex broker, the orders will be routed directly to a bank, which is technically referred to as a liquidity provider, and a commission will be charged for every round trade. Alternatively, a Forex broker may mark-up the quoted price, applying a spread to the buy and sell rates to cover its costs and profit.

Compare Forex brokers

If you plan on opening a trading account with a Forex broker, you would want to do it with the one that will serve your best interests. You can compare brokers by their features and read reviews posted by real traders on EarnForex.com - a free Forex education website: https://www.earnforex.com/forex-brokers/.

Impact of leverage

Let us imagine that we anticipate the euro to rise versus the US dollar and we have $1,000 in our trading account at a Forex broker. If we use the $1,000 to buy the euro vs. dollar (aka EUR/USD) at $1.17 and sell it at $1.18, we would make a profit of just $8.54 ($1,000 / $1.17 * $1,18 - $1,000). The low traded volume makes little commercial sense to the Forex broker as well. Thus, to increase trading volumes, a broker puts its money online and allows a trade size of as much as 1000 times the trader's capital. It is not money that can be withdrawn or used for some other purpose, but a capital to be traded. The trade size allowed by a Forex broker above the capital held by a trader is referred to as the leverage.

Now, in the above example, if a leverage of 1:100 is used to open a long position (buy) in the EUR/USD pair at 1.1700, and then sold at 1.1800, the account size would have nearly doubled at the end of the trade ($100,000 / $1.17 * $1,18 - $100,000 = $854.70). It should be remembered that misuse of leverage would result in losing the entire capital in no time.

In case of a losing trade, the trader's funds are deducted first. Thus, a trader should keep a minimum prescribed capital to hold a position open in the Forex market. That amount of capital is referred to as the required margin. If the available capital in the trader's account falls below the required margin level, the trade would be closed off automatically using such mechanisms as margin call and stop-out. Major currencies rarely gain or lose more than 1% of its value in a day. Yet, considering the leverage provided by a Forex broker, even small exchange rate changes may result in a huge profit or loss. It is not uncommon to see professional traders earn 50-100% of their capital in a short span of time. Beginners who do not manage the broker's leverage wisely lose their entire investment in just a few trades. Proper application of leverage and position sizing ultimately decides the fate of a trader.

A pip and its value

If you look at the EUR/USD example above, you would notice that the currency pair (euro vs. US dollar) is quoted as 1.1700 or 1.1800. When you see a Forex quote, the last digit in this quote denotes a pip - the minimum exchange rate change a currency pair can experience. For example, if the rate changes from 1.1700 to 1.1701, it means that the currency pair gained 1 pip. Or if the rate goes down from 1.1800 to 1.1790, it is said that the pair lost 10 pips. The value of the pip depends on the size of the position and the currency pair. A standard lot size in Forex is 100,000 units of currency. If you trade one standard lot of EUR/USD currency pair, one pip is worth exactly €10 (€100,000 * 0.0001).

Sometimes, traders and brokers use extended quotes that have 5 decimal places instead of 4. Such quote may look, for example, like 1.75000. In that case, there is a fractional pip at the end of the quote. The value of a fractional pip is 1/10 of the normal pip. For example, if EUR/USD rises from 1.72301 to 1.72344, it is said that the currency pair gained 4.3 pips or 43 fractional pips. If you would be in such a trade with a 1 standard lot position, your profit would be €43.

Capital requirements

There is no minimum amount that can be exchanged physically at the counters of an exchanger. However, a person will get a better exchange rate if converting large sums of cash. The spot Forex market works in a very similar fashion. There were times when Forex trading was only possible for wealthy investors. The availability of high-speed internet, institutional level trading platforms, leverage, and competition among retail brokers have ensured that Forex trading can be started with a very small capital. There are Forex brokers that allow a trader to begin currency trading with as little as $1. Such possibility is provided for beginners to test the waters before making it a part-time or full-time profession.

Placing orders

A customer may be asked to fill up a KYC form and provide identification documents while doing a regular currency exchange through an authorized money exchanger or a Forex department of a bank. If large sums are involved, the details will have to be verified and only then the actual exchange takes place.

Similarly, to open a live Forex trading account, a KYC form should be filled up online and relevant documents (identity and address proof) should be provided by a customer. Once the documents are processed, a login and password will be provided by a broker. Invariably, all the Forex brokers offer more than a single way of deposit. Once a suitable trading platform (MetaTrader, cTrader, etc.) is downloaded, the appropriate login details can be entered to access the account. Deposits can be made using a range of electronic payment systems, a credit or debit card, bank transfer, and even via cryptocurrencies (such as Bitcoin, Ethereum, Litecoin, and others).

The menu-driven software can be used to easily buy or sell a currency pair. Just input the number of lots to be bought or sold and execute the trade at a current market price or some stop/limit price. The image below shows how simple it is to place a long (buy) trade in a currency.

Opening and closing trades without staying in front of screen

Speculative Forex trading involves buying and selling a currency pair at a particular rate and then waiting for it to go up or down to exit at a profit. Most brokers allow trading on a 24x5 basis. Thus, there are high chances for a currency to reach a particular level when we are away from the computer screen. Fortunately, trading platforms used in Forex allow opening and closing trades at given levels. Pending orders are used to enter a trade when the rate reaches a particular level:

A buy limit order is used to buy when the rate reaches some level below the current price.
A buy stop order is used to buy when the rate reaches some level above the current price.
A sell limit order is used to sell when the rate reaches some level above the current price.
A sell stop order is used to sell when the rate reaches some level below the current price.

Additionally, a trader can feed his particular target rate (called take-profit) to close position at profit when entering a trade. The entry and take-profit levels are stored on the Forex broker's server. Thus, even if a trader shuts down the computer after placing an order, the trade would still get executed when it hits the input level. So, a trader who is confident in his analytical skills needs not to spend too much time in front of a PC.

Limiting risk

Now, imagine that an unexpected news comes in and the currency undergoes a trend reversal. In such circumstances, a trader will attempt to close the trade as long as he is in front of the computer. But even if the trader is not in front of the screen, a trade that moves against the desired direction can be closed and losses can be limited.

To limit risk, a trader should decide the maximum loss that he is willing to accept for the expected returns. Usually, professional traders prefer a risk-to-reward ratio of not less than 1-to-2. Alternatively, the exit level can be based on technical or fundamental analysis. Once the maximum loss level is decided, a stop-loss order can be placed. Fortunately, all the trading platforms allow a stop-loss order to be placed at the time of opening a trade or at a later stage. As mentioned in the earlier paragraph, the levels will get triggered even if the platform remains switched off.

Conclusion

As you can see, there is a lot of difference between exchanging currencies and trading Forex for profit. While speculative FX trading may not be suitable for everyone, those who have surplus amount of capital can try trading currencies in the Forex market - one of the most lucrative professions, which can lead to financial independence in the long-run.

Read more forex articles and get more currency trading information at www.earnforex.com

This article was provided by wwww.earnforex.com

www.exchange-rates.com recommends visiting www.earnforex.com for forex broker reviews, comparisons and more.



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