How Do You Make Money Trading Currencies? (2024)

The foreign exchange market (forex or fx) is the largest financial market in the world, with a daily trading volume of over $7.5 trillion. That dwarfs the stock market, yet it remains largely invisible to the average investor. When geopolitical tensions, interest rate decisions, and economic data reshape the value of currencies, traders seek to capitalize. But in a market where many retail traders lose money, what separates the winners from the losers?

Investors can trade almost any currency in the world through forex. To make money, you are betting that the value of one currency will increase relative to another. The expected return of currency trading is like money market trading and lower than stocks or bonds. However, it's possible to increase both returns and risk by using leverage.

Below, we take you through the main aspects of forex trading, the pitfalls to watch out for, terms to know, and strategies often used by successful traders.

How To Buy and Sell Currency

Currency trading is a deceptively simple concept. Traders aim to buy a currency when it's undervalued and sell when it's overvalued, profiting from the difference. However, the execution of this strategy is far more complex. Unlike stocks or commodities, currencies are always traded in pairs. When you buy one currency, you're simultaneously selling another. For instance, if you believe the euro will strengthen against the U.S. dollar (USD), you would buy EUR/USD, effectively going long on euros and short on dollars.

Suppose you see a currency quote for a EUR/USD pair of 1.1256. In this example, the base currency is the euro. USD is the quote currency. In all currency quote cases, the base currency is worth one unit. The quoted currency is the amount of currency one unit of the base currency can buy. Based on the above example, all that means is that one euro can buy 1.1256 USD. An investor can make money in forex through an increase in the value of the quoted currency or a decrease in the base currency. Below is the exchange rate for eur/USD since the euro's introduction:

In the example above, one euro can purchase $1.1256 and vice versa. To buy the euros, the investor must first go short on the U.S. dollar to go long on the euro. To make money on this investment, the investor will have to sell back the euros when their value appreciates relative to the U.S. dollar.

Suppose the value of the euro appreciates to $1.1266. On a lot of 100,000 euros, the investor would gain $100 ($112,660 - $112,560) if they sold the euros at this exchange rate. Conversely, if the EUR/USD exchange rate fell from $1.1256 to $1.1246, the investor would lose $100 ($112,460 - $112,560).

Today, most currency transactions occur electronically, with traders using sophisticated platforms that offer real-time quotes and near-instantaneous execution. These platforms allow traders to place various orders, from simple market orders to complex conditional trades that automatically trigger based on preset price levels.

One notable aspect of currency trading is its use of leverage. Brokers typically offer leverage ratios of 50:1 or higher, allowing traders to control significant positions with relatively small amounts of capital. While this can amplify profits, it can quickly blow up your trading account.

The buying and selling of currencies is not just a game for speculators. Businesses engaged in international trade regularly use the forex market to hedge against currency fluctuations. Central banks take part to manage their nations' money supply and exchange rates. Understanding these diverse market participants and their motivations is crucial for anyone looking to navigate the complex currents of the foreign exchange market.

Advantages for Active Traders

Unlike stock exchanges, which have shorter opening hours, currency trading continues around the clock from Sunday evening to Friday night. This allows traders to react immediately to global events, regardless of their time zone. The forex market never sleeps, offering flexibility for traders to capitalize on prospects as they arise.

Another advantage is the market's exceptional liquidity. With trillions of dollars changing hands daily, traders can typically enter and exit positions with minimal slippage, even for large trade sizes. This high liquidity also contributes to tighter spreads (the difference between bid and ask prices), reducing transaction costs for active traders who may trade many times a day.

The forex market's accessibility is another key advantage. With the advent of online trading platforms, you can start trading currencies with relatively small amounts of capital. Many brokers offer micro-lot trading, allowing newcomers to dip their toes in the market without risking large sums. This accessibility has been part of the reason forex trading has vastly increased in the last two decades:

In addition, the ability to profit in both rising and falling markets sets forex apart from traditional stock trading. Since currencies are always traded in pairs, there's always potential for profit, whether a particular currency is strengthening or weakening. This two-way market provides active traders with constant opportunities, even in times of global economic uncertainty.

Finally, the forex market offers access to much higher leverage levels for experienced traders. Regulation T sharply limits the maximum leverage available to stock investors in the U.S. It's usually possible to get 50 to 1 leverage in the forex market, and it is sometimes possible to get 400 to 1 leverage. This high leverage is among the reasons forex is often considered a risky trading area.

Getting Started With Forex

The forex market was once much less accessible to average investors, but getting started is easy now. Many large brokerages, such as Fidelity, offer forex trading to their customers. Specialized forex brokers, such as OANDA, make sophisticated tools available to traders with balances as low as one dollar.

Here are some steps to follow to boost your chances of becoming a successful forex trader:

1. Master the basics: Before engaging in forex trading, you must learn the jargon and how it works. You’ll want to understand trading strategies, including leverage and stop-loss orders, and the fundamental factors that impact exchange rates.
2. Find a broker: Currencies can be traded on various websites, but they are not all the same. You need to choose which one works best for you. Essential things to consider when comparing forex brokers include their fees, margin rates, customer service, regulatory compliance, choice of currencies, and additional resources, such as tools and research material.
3. Start with a demo account: Trading platforms usually offer investors the chance to test it first. With a demo account, you trade, but no money is on the line. If you are new to forex trading or changing brokers, play around with the demo account first.
4. Research currencies and identify trading prospects: You should have a basic understanding of how to trade currencies. Now, it’s time to come up with some plays. Research is good, but don’t mindlessly follow whatever some so-called expert says online. Do your homework. Also, try to execute your trade before an event likely to move the currency, such as publishing critical economic data. With trading, timing is essential.
5. Start small: Once you’ve identified a prospect, you may be tempted to bet everything on it. Try to refrain from doing that. Be rational, and remember you are still new to this and probably more prone to errors than more seasoned traders. Discipline in forex trading, as with other areas of the market, is a central part of any success.
6. Monitor and manage positions: Before pulling the trigger, you should know your exit points for either taking profits or a loss.Stick to your principles, and don’t get pulled down by your emotions.
7. Keep a journal: One of the best ways to become a good investor is to learn from past mistakes. Keep a record of all your trades and periodically review it to hone your investing strategy.

Common Forex Terms

Like most technical fields, the forex market is full of jargon. Here is a list of some important terms to know:

The Bottom Line

To make money trading currencies, you must correctly guess that your chosen currency will rise or fall in value against another. You can go long, meaning betting the base currency will rise against the quote currency, or short, meaning you think the base currency will fall in value against its pair.

To increase your chances of success, you need a good understanding of trading strategies, patience and discipline, and a decent understanding of the currencies being traded. This means being familiar with their economic environment and the dates economic data will be published.