The key principle of forex
trading is simple. You buy one currency with another currency at the
present exchange rate, so you are in effect going long of the first
currency and short of the second currency. That is, your position will
increase in value if the relative strength of the first currency against
the second currency increases, as you can now sell the first currency
back for a greater amount.
For instance, if you had
bought GBP £10,000 in August 2013 it would have cost you around USD
$15,500 at the prevailing GBP/USD exchange rate. By late June 2014 the
pound had increased in value against the dollar, so you could now have
closed out your position by selling your £10,000 for around $17,000. You
began with $15,500 and you now have $17,000, a profit of $1500.
Example: buying the euro
Say the euro is trading
against the dollar at 1.3550-1.3551 and you think the euro is set to
rise. You can choose either to buy a certain stake per pip as a spread bet, or to buy a certain number of CFD contracts, at the offer price of 1.3551.
For example, you might buy 10
CFDs at 1.3551. Each CFD contract is the equivalent of 10,000 of the
base currency, in this case the euro, so you are buying the equivalent
of €100,000 at 1.3551 which equals $135,510.
Suppose you are right and the
euro rises against the dollar to 1.3670-1.3671 later in the day. You
decide to close your position by selling your 10 CFDs at the bid price
of 1.3670. You are effectively selling at $136,700, making a profit of
$1190 (this is converted into your account currency if necessary).
Alternatively, if you are
spread betting, you might have bought £10 per pip at the offer price of
1.3551. To close your position you sell at the bid price of 1.3670. The
difference between your opening price and your closing price is 119 pips
so in this case your profit is 119 x £10 = £1190.
Whether you are spread betting or CFD trading,
you will need to put down a margin deposit to open your position. This
is typically a fraction of the full value of your position: the ratio of
your margin to the value of your position is known as leverage. Find
out more about our exceptional leverage.