Q. How Does Currency Trading Work

A. Currency is traded in pairs (for example AUD/USD), the cross rate refers to how much of one currency you can buy by selling the other. If the quote for the AUD/USD is 0.94, this means I can buy 0.94 USD (94 cents) for every $1 AUD I own.

Now, lets say I believe the AUD is going to rise in value in relation to the USD based on some news I read. I could take out an AUD/USD position with a Forex Broker. In the Forex broker platform all I need to do is click BUY on the AUD/USD quote and enter the quantity I want.

Example:

BUY AUD/USD @ 0.9400
(the base currency for the AUD/USD is the AUD, so 1 mini Forex contract would result in buying $10,000 AUD)
COST = 10,000 x 0.9400 = $9,400 USD

I decide to hold the currency for 2 months, here’s what happens every day in my account:
- At the end of the day my profit/loss is calculated and added or subtracted from my account balance.
- I get credited with the difference in interest rates between the AUD/USD, currently the AUD yields 7.73% and the USD yields 3.01%. The difference therefore is 4.72%, this works out to approximately $9,400 x 4.72% / 365 = $1.22 USD per day.

Over the 2 months it turns out I was right and the AUD/USD price is now 0.9815 and I decide to close the position. I do this by clicking on the open position in my Forex broker platform and selecting close trade, or I could also do it by clicking SELL on the AUD/USD quote and entering the same quantity as I bought.

SELL AUD/USD @ 0.9815
PROCEEDS = 10,000 x 0.9815 = $9,815 USD

PROFIT = $9,815 - $9,400 = $415 + interest

Now, wouldn’t it be nice if my Forex broker let me do this for free? Of course, but that isn’t the case. In fact, my Forex broker charged me when I bought the AUD/USD through the spread. In the quote window for the AUD/USD at the time there were two prices, 0.9400 / 0.9396, the difference between the two prices is referred to as the spread and is 0.0004 or 4 pips in this case and is charged when you BUY a currency pair. This 4 pips equals 10,000 x 0.0004 = $4 and is included in the BUY price.