1.2 How to earn money in FOREX
Forex trading involves buying and selling different currency pairs, which can be thought of as simultaneously buying one currency and selling another.
Here’s a simple example:
When the USD/JPY exchange rate is 130 (meaning 1 US dollar can be exchanged for 130 Japanese yen), let’s say Xiao Ming exchanges 1 million Japanese yen for 10,000 US dollars and holds onto it. This process is called going long or buying USD/JPY. By exchanging Japanese yen for US dollars, he essentially gets rid of the Japanese yen and has US dollars on hand.
One week later, when the exchange rate rises to 140 (meaning 1 US dollar can be exchanged for 140 Japanese yen), Xiao Ming exchanges his 10,000 US dollars back into 1.4 million Japanese yen. Similarly, this process is called going short or selling USD/JPY. In this case, he sells the US dollars and buys Japanese yen. Through this process, Xiao Ming has made a profit of 100,000 Japanese yen in one week.So, this is the principle of making money through Forex by taking advantage of exchange rate differences.
While we understand the principle, the example above seems a bit cumbersome. Xiao Ming wanted to profit from the exchange rate difference, but he had to exchange physical currencies twice. If he wanted to make 1 million Japanese yen, wouldn’t he need to prepare 13 million Japanese yen as capital?
Is there a way to reduce the capital required and eliminate the need to exchange physical currencies while still making money from exchange rate differences?
The answer is yes. With the development of the internet, electronic network trading has become mainstream. A financial derivative tool called Contract for Difference (CFD) has emerged, which allows Xiao Ming to profit from price movements without the need to hold physical currencies.
CFD contracts are offered by Forex brokers, and Xiao Ming can now operate using a trading platform called MT4 on his smartphone or computer. With a simple click to buy or sell, he can instantly complete the complex operations mentioned earlier.
Furthermore, most Forex brokers can offer customers leverage ranging from 30 to 500 times their initial capital. Going back to the example above, where Xiao Ming would have needed 13 million Japanese yen as capital, if he chooses 500 times leverage, he would only need 26,000 Japanese yen. This is the appeal of Forex CFDs.
Leverage is a double-edged sword; while it can magnify profits, it can also magnify losses. If the exchange rate moves in the opposite direction, Xiao Ming’s capital could be at risk of going to zero.