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Previous Lesson: Recruit - What is forex? | Next Lesson: Private First Class - Selecting a broker

How Does Forex Work?

Topics for this lesson:

a) The Quest for Money
b) The Simplistic Nature of Forex
c) The Difficult Nature of Forex
d) Profiting through Speculation
e) Starting Small
f) Pip is a Funny Name
g) That's a Lot
h) Making the Most of Leverage
i) All Night Long

The Quest for Money

I know what you’re thinking?

What’s everyone fighting for out there anyways?

The answer is simple. Money.

Various currencies around the globe do not have the same value. And to top it off, their values fluctuate every day as the war wages on. As a result of this fluctuation you are allowed an opportunity to make money.

How you ask?

First things first, recruit. Drop and give me twenty. You keep asking questions as if I’m not going to provide you the information you need.

Now that you gave your arms a workout, let’s give your mind a little workout. Allow me to give you a simple example of how you can profit in the Forex market.

The Simplistic Nature of Forex

Let’s say you have $100,000 in your bank account. And for the sake of make believe you live in Dallas, TX. Mind you, the greatest city in the free world. Feel free to drop and give me another twenty if you disagree.

Now lets say you had to move to London for a new job. You take every penny you have and set sail for the land on the other side of the Atlantic. Except in London, you can’t go on your shopping spree with dollars. You need the British Pound. Your bank was kind enough to exchange all of your currency from United States Dollars into Great British Pounds.

Let’s assume the current exchange value is GBP/USD = $1.57

So when you arrive in London and get all situated in your new abode. You find that you’re $100,000 USD is now £ 63694.27 GBP.

You decide to not spend any of your money out of your new British account and only live off your new salary. After one month, you get fired from your job. Apparently, you were too busy having a good time seeing all the sights of Europe that you forgot to turn in your work assignments on time. Perhaps just another reason you’ve decided to enlist in this boot camp.

Upon your return to the States, you head back to the bank to exchange your Pounds back into Dollars.

The current exchange value is now GBP/USD=$1.69.

When you look at your bank statement you’ll see that you now have $107,643.32.

Now wait just a minute there recruit! You made $7,643.32 for doing nothing!

The Difficult Nature of Forex

Naturally, you think you hit a gold mine. Making money has never been easier. All you have to do is just exchange Dollars into Pounds, wait a month, then convert back into Dollars. And by making nearly $8,000 a month you won’t even need to work.

So you keep your initial profits and convert your $100,000 USD into GBP.

The current exchange rate is still GBP/USD=$1.69. So now your account has £59,171.60 in it.

A month passes by and you eagerly look to cash in your profits.

The current exchange rate is now $1.55.

The pile of money handed to you just don’t look right. You have the teller recount it to make sure your $8,000 of profit is there. When it’s not, you have the bank manager do a recount. He informs you that the teller was correct in the count. Your account after the exchange is now $91,715.

How could this be?!?!? You lost thousands of dollars!

Well recruit. It serves you right. Unknowingly you just pitted yourself in the greatest financial battlefield in the world. You were unprepared and you became another casualty. So recruit, what made the difference? Why did you profit at one point and then another completely fall flat on your face?

Profiting through Speculation

It’s all about speculation. Generally the value of a currency is in relation to the economic status of a country. So naturally if an economy is doing well, the value of their currency will increase. Likewise if the economy is in the gutter, the value of the currency is likely to decrease.

So how does one go about finding out the economic status of a country? Well for starters, picking up a newspaper wouldn’t be a bad idea. If King Muckymuck shot and killed King Duckyduck and that thrust their two countries into war, it probably will have a negative impact on their currencies.

The opposite can be true as well. If King Muckymuck told the entire country that they have more gold and goats than they ever could have imagined a country to have, then it’s possible their currency might increase in value.

Starting Small

What’s that you say? You don’t have $100,000 to just invest into the markets? Well, that’s quite all-right recruit, because this arena allows anyone to enter with any amount of money. And there are dozens of companies that will let you borrow their money to trade with. With even a single dollar, you can purchase upwards of $400 worth of foreign currency. It’s called leverage. And we’ll talk more about that later. For now I need for you to understand how a trade actually works.

You ever heard the phrase, “a fraction of a penny”? Well have you ever seen an actual fraction of a penny? Of course you haven’t. But let me tell you recruit, it exists. And people trade fractions of pennies all day long. You see, when a currency moves, it doesn’t move cents at a time. But rather in hundredths and sometimes thousandths of a penny.

Pip is a Funny Name

Remember when I told you that at the time you took off to London the current exchange was GPB/USD = $1.57. In actuality it was GPB/USD = $1.5713. Currency is measured in what is called a pip. Funny little name isn’t it? If price went from $1.5713 to 1.5714, it is said to have increase one pip. So for every 100 pips, price has increased by one cent.

Something is missing, isn’t it? How can you possible make money when currency is only moving a fraction of a penny?

That’s a Lot

Well you see recruit, currency is traded in lots. A standard lot is 100,000 units. So if you were to open a trade to purchase USD, you would be purchasing $100,000 units at a time. Now for those that do not desire to trade that much, you can find a broker that will allow you to trade mini or micro lots. A mini lot would be 10,000 units per order and a micro would be 1000 units per order.

Now every currency has a pip value based on a standard lot. I can be a nice guy sometimes so to keep it simple for you recruit, we’ll just stick to talking about dollars and cents. The pip value for USD is $10 per standard lot. Likewise it is $1 and $.10 respectively if you are trading mini and micro lots. Depending on their individual values, other currencies will be deviated off the $10 per pip standard. But no worries, your broker calculates all that for you when you enter into a trade.

Making the Most of Leverage

Now before I said that you can trade with a dollar. That’s entirely true. Might not be the most feasible option, but it is doable. Nearly every broker offers you leverage. What that means is they will allow you to trade a dollar amount up to 400 times the amount you have in your account. So let’s say you want to invest that entire dollar and maximize it’s potential. You would enter a trade with one mini lot or ten micro lots. Assume for a moment that price went up one cent. Based on what you just learned, how much money would you have just made?

If the mini lot is valued at $1 per pip, and you just made 100 pips. You essentially just made $100 from a single dollar bill. Now that’s pretty impressive.

However, if I sent you into battle thinking you can turn every dollar into $100, you’d take a shot to the head the second you stepped off the helicopter.

Leverage can work against you, so it’s something that you should take advantage of, but don’t be foolish enough to abuse it. What would happen if you had went down a single pip? Your one-dollar would be gone and your account busted. You would be better off trading micro lots to at least give you more advantage to profit with your dollar. However, we’ll talk more about money management a little later.

All Night Long

All right recruit, I see the glow in your eyes now. You are eager for battle. However, you need to know when and where the battle even takes place. Currency is traded 24 hours a day, 5 days a week. Even the roughest of toughest of soldiers need to have the weekends off.

There are four primary markets around the globe where the 4 trillion dollar daily battle is waged. Sydney, Tokyo, London, and New York. The largest battles take place during London and New York’s trading hours. But if either time is inconvenient for you, do not fear. There’s still plenty of money to be made around the clock.