Forex Investment Article:

Forex Trading: Calculating Profit And Loss In Foreign Currency Trading
By Gregory DeVictor
The foreign exchange market, or market, is an around-the-clock cash market where the currencies of nations are bought and sold. 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 investment increases or decreases because of changes in the currency exchange rate or rate. These changes can occur at any time, and often result from economic and political events. Using a hypothetical investment, this article shows you how to calculate profit and loss in trading.

To understand how the exchange rate can affect the value of your investment, you need to learn how to read a quote. 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 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 market, and it is always treated as the base currency in any quote where it is one of the pairs.

Let's go now

to our hypothetical investment to show how you can profit or come up short in trading. In this example, your pair of currencies are the U.S. Dollar and the Euro. The 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 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 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 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 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, 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.

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