by: Gregory DeVictor
The foreign exchange market, or Forex market,
is an around-the-clock cash market where the currencies of nations are
bought and sold. Forex trading is always done in currency pairs. For
example, you buy Euros, paying with U.S. Dollars, or you sell Canadian
Dollars for Japanese Yen. The value of your Forex investment increases
or decreases because of changes in the currency exchange rate or Forex
rate. These changes can occur at any time, and often result from
economic and political events. Using a hypothetical Forex investment,
this article shows you how to calculate profit and loss in Forex
trading. To understand how the exchange rate can affect the value of
your Forex investment, you need to learn how to read a Forex quote.
Forex quotes are always expressed in pairs. In the following example,
your pair of currencies are the U.S. Dollar (USD) and the Canadian
Dollar (CAD). The Forex quote, USD/CAD = 170.50, means that one U.S.
Dollar is equal to 170.50 Canadian Dollars. The currency to the left of
the "/" (USD in this example) is referred to as base currency and its
value is always 1. The currency to the right of the "/" (CAD in this
example) is referred to as the counter currency. In this example, one
USD can buy 170.50 CAD, because it is the stronger of the two
currencies. The U.S. Dollar is regarded as the central currency of the
Forex market, and it is always treated as the base currency in any
Forex quote where it is one of the pairs. Let's go now to our
hypothetical Forex investment to show how you can profit or come up
short in Forex trading. In this example, your pair of currencies are
the U.S. Dollar and the Euro. The Forex rate of EUR/USD on August 26,
2003 was 1.0857, which means that one U.S. Dollar was equal to 1.0857
Euros, and was the weaker of the two currencies. If you had bought
1,000 Euros on that date, you would have paid $1,085.70. One year
later, the Forex rate of EUR/USD was 1.2083, which means that the value
of the Euro increased in relation to the USD. If you had sold the 1,000
Euros one year later, you would have received $1,208.30, which is
$122.60 more than what you had started with one year earlier.
Conversely, if the Forex rate one year later had been EUR/USD = 1.0576,
the value of the Euro would have weakened in relation to the U.S.
Dollar. If you had sold the 1,000 Euros at this Forex rate, you would
have received $1,057.60, which is $28.10 less than what you had started
out with one year earlier. As with stocks and mutual funds, there is
risk in Forex trading. The risk results from fluctuations in the
currency exchange market. Investments with a low level of risk (for
example, long-term government bonds) often have a low return.
Investments with a higher level of risk (for example, Forex trading)
can have a higher return. To achieve your short-term and long-term
financial goals, you need to balance security and risk to the comfort
level that works best for you.