Leverage

Leverage is conventionally displayed as a ratio, such 100:1 or 200:1.
Foreign Exchange, often referred to as the "Forex" or "FX" market, is the arena where a nation's currency is exchanged for that of another. Unlike other financial markets, the Forex market has no physical location and central exchange. It operates through a global network of banks, corporations and individuals. Currencies are traded in pairs, for example Euro/US Dollar (EUR/USD) or US Dollar/Yen (USD/JPY).

Three major Forex market trading tools - Day trade, Spot and Forward:

Day trade: Based on the current market price. Daily transactions settlement occurs within one business day.

Spot: The current market price. Spot transactions settlment usually occurs within two business days.

Forward: The pre-specified exchange rate for a foreign exchange contract settlement at an agreed future date, based upon the interest rate differential between the two icluded currencies.

Spot Trading Example



The Spread: The EUR/USD rate is quoted at '1.2500/05'. This quote represents the bid/ask spread for EUR vs USD.

The Ask: The offer rate of 1.2505 is the rate at which you can exchange your USD for EUR or, this means purchasing EUR with USD, or BUY EUR and SELL USD.

The Bid: The bid rate of 1.2500 is the rate at which you can Sell EUR to buy USD.

Going Long: You believe that the Euro will strengthen against the US Dollar, and decide to BUY or 'go long' EUR 500,000 at 1.2505 (ask price).

Opening Buy: Customer buys EUR 500,000 at 1.2505
Quote (bid/ask) 1.2500/05
Buy Price 1.2505
Volume EUR 500,000
Initial margin (Leverage as high as 100:1) EUR 5,000

Later: Your prediction proved to be correct and the Euro appreciates against the US Dollar. The quote on EUR/USD is now 1.2590/95. To close your position, you decide to SELL EUR 500,000 at 1.2590 (bid price).

Closing Sell: Customer sell EUR 500,000 at 1.2590
Quote (bid/offer) 1.2590/95
Sell price 1.2590
Volume EUR 500,000
Profit/loss $ 4,250 profit

Profit/loss Calculation:
Size of trade x (sell price - buy price) = profit & loss USD
500,000 x (1.2590 - 1.2505) = $ 4,250 profit

Or, converting the $ 4,250 back to EUR at a rate of 1.2590:
(Profit/loss : EUR rate) = profit & loss EUR
(4,250 : 1.2590) = EUR 3,375.7 profit

By closing your position you realize a gross profit of EUR 3,375.7.
Had you estimated incorrectly, and sold EUR at 1.2500 and then bought EUR at 1.2595, a loss of $ 4,750 would have been sustained.