A foreign currency trade, step by step
Here’s an example of how a currency trade might work:
• A person who believes that the European economy is strengthening decides to buy euros, thinking this currency will become more valuable in relation to the dollar.
• The person opens an account with one of 13 registered foreign exchange broker-dealers for home investors, downloads the dealer’s proprietary trading platform onto his computer and deposits $500, typically the minimum stake.
• Opening the trading platform, the customer sees that the dealer is willing to sell a euro for $1.45000. He decides to trade what is called the euro dollar pair, written as EUR/USD. All currencies are traded in similar pairs, quoted to five decimal places.
• The dealer requires a minimum bet of 10,000 units of a currency, so to open the trade, the customer has to go in for $14,500. Because of the 50-to-1 leverage allowed in currency trading, the customer has to put up only 2% of this bet, or $290.
• If the EUR/USD drops to $1.42050, the value of the outstanding trade falls more than the customer’s 2% deposit ($290) and the trade is automatically closed out, wiping out the customer’s deposit. Note that the dealer can change the prices as it desires, which means it can temporarily bump down the value of a currency pair so the customer’s losses are larger than the deposit, knocking out the customer.
• If instead the EUR/USD rises to $1.48000, the customer can sell the pair back for $14,800, booking a $300 profit.
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