How to Make Money from Forex Trading

by Peng D. Manager

How to Make Money from Forex Trading

For anyone not familiar with the forex market, the concept of selling money for a profit may be a difficult one to grasp.

But truth be told, the foreign exchange market is one of the simplest to understand its basics, though it can get very complex as you advance in your forex trading education and training.

In most markets, traders buy (or produce) a product or service and sell it at a selling price that is higher than the trader’s buying price or production costs.

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That means that for most traders in every market to be profitable, they have to buy at low cost and sell at a high price.

In a simple equation, this goes like this:

Profits = Selling Price – (Buying Price + Costs)

The forex market works on this very same principle to enrich forex traders.

However, to achieve profits in the forex market, you do not have to only rely on buying low and selling high. You can also start by selling high then buying back at a lower price.

Buying and Selling Money

The most traded currency in the world is the American Dollar (USD) so it will form the basis for most examples in this article.

Let’s say you have just arrived in Europe and you need €1,000 to cover your cab, hotel, and meals expenses for the few days you will be there.

You go to a forex bureau and they tell you that one of your American dollars will get you €0.75. So to get €1,000, you give them $1,333.33.

After your stay there and after a few such transactions minus your expenses, you find yourself remaining with €1000 once more.

At the exchange counter, they tell you the rate is now $1 = € 0.78. So in exchange for your €1000, they give you US $1,282.05. In effect, you have just made a $51.28 loss.

That is a simple illustration of how you sell and buy money. If you are a forex trader, your role is to take advantage of the fluctuations in exchange rates and profit from them.

If the traveler in our example was a forex trader, s/he would have bought his euros at a lower price than s/he sold them.

Forex Market Analysis

Following our example above, you are probably wondering why the exchange rate shifted from $1 = €0.75 to $1 = €0.78 within that period.

Like all other markets, the prices of currencies are influenced by market forces of demand and supply.

The increase in the price of the euro in relation to the dollar in our example could have been a result of the following market fundamentals:

An increase in the demand for the euro
A decrease in the supply of the euro
A decrease in the demand for the dollar
An increase in the supply of the dollar

A trader has to study the market and identify factors that may lead to these market forces happening.

This will help him accurately predict future prices and use that prediction to either buy or sell currency in anticipation of making profits later.

There are three types of forex market analysis: Fundamental analysis, technical analysis, and sentiment analysis.

Fundamental Analysis

In fundamental analysis, a trader will analyze economic, trade, and political activities that may affect the price of a currency in relation to another.

For instance, if there is an increase in the imports the US gets from Europe, there will be a higher demand for the Euro and this will lead to a higher currency price for the euro in relation to the dollar.

Technical Analysis

The forex market is a highly volatile and liquid market where currency prices change each and every second, 24 hours a day.

Technical analysis involves predicting these price changes as they happen. A sustained price change in a particular direction becomes a price trend and following this trend is what gives most forex traders their profits.

Sentiment Analysis

There are times when many traders share a feeling for the future performance of one currency in relation to another.

This shared feeling is referred to market sentiment. Sentiment analysis involves the study of the prevailing market sentiment and using that to predict future currency prices.

Currency Pairs

When trading currencies, you use one currency to buy another currency. In our illustration, our traveler first used dollars to buy euros then later used euros to purchase dollars.

This combination of two currencies traded against each other is referred to as a currency pair.

As said before, the US dollar is the most traded currency in the world. There are 8 most traded currencies in the world and they are referred to as the currency majors.

They are the American Dollar (USD), the British Pound (GBP), the European Euro (EUR), the Japanese Yen (JPY), the Swiss Franc (CHF), the Canadian Dollar (CAD), the Australian Dollar (AUD), and a recent addition to the Majors the South African Rand (ZAR).

The currency pair majors are the EUR/USD, USD.JPY, GBP/USD, AUD/USD, USD/CHF, USD/CAD, and USD/ZAR.

You can trade any currency of your choice against another. However, the majors offer the highest liquidity and offer the most profitability. Moreover, many brokers only offer the currency pair majors for trading.

Spreads

Earlier in the article we spoke of the buying price, the selling price, and the cost. The costs incurred by forex traders are known as spreads.

A forex broker buys currency at a particular price, say EUR/USD = 1.3020.

The broker will offer to buy from traders at EUR/USD = 1.3018 and sell to them at EUR/USD = 1.3022. These are referred to as the bid price and ask price respectively.

The cost of buying and selling currency from a broker is referred to as the spread and is the difference between the bid price and the ask price.

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Summary

To be profitable, a forex trader needs to buy low and sell high or sell high and buy low.

Using forex market analysis methods, the trader has to correctly predict currency price movements and ensure that the exchange profits are high enough to cover the spread.

And, remember that forex trading is not a get rich quick scheme.