The forex market uses margins to increase your profits

Forex is a nickname for the foreign exchange, a vast market of trading in which

the commodity is money itself. In the forex market, traders are buying and selling

foreign currencies -- trading dollars for euros, pounds for yen, and so forth.

Forex is profitable because national currencies fluctuate from day to day based

on predictions of the nation’s gross domestic product and other factors. As with

the stock market, the idea with the forex is to buy low and sell high: Buy a lot of a

particular currency when it’s weak, then sell it when it becomes stronger.

For example, bad financial news in Great Britain means that forex traders will be

selling off their British pounds as fast as possible, as the pound is about to

become devalued. Once the pound recovers, those traders will sell it for

something else, thus turning a profit.

Though we talk of “buying” and “selling” pounds, euros, yen and francs, the

transactions performed in the forex are not literal. That is, if you want to buy

100,000 euros, you don’t have to withdraw the equivalent U.S. dollars from your

bank account and swap them out for a big stack of euros. Everything is done on

paper only, though the resulting profits and losses are real.

Because the transactions are not done physically, there is room in the forex for

what are called “margins” or “leverage.” Put simply, this means you don’t have to

actually put up the full amount of the position you’re taking. Usually the margin is

1%, meaning that when you put $1,000 into it, you’re actually getting $100,000.

Of course, margins multiply your losses as well as your profits, so you have to be

careful.

One of the reasons for allowing a 100:1 margin like this is that the major world

currencies in the forex market usually fluctuate less than 1% a day. (In the stock

market, a typical stock might fluctuate as much as 10% in one day.) With

changes that small, your daily loss or gain on an initial investment of $1,000

would be almost imperceptible, usually less than $10 either way. By multiplying it

by 100, the gains and losses in the forex market are more pronounced.

With leverage implemented that way, the basic “lot” for buying and selling

currencies is usually 100,000 (which of course only costs 1,000). Most firms that

handle day-trading on the forex market don’t go any lower than that.

 

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