How does Online Forex Currency Trading Work?
We explain the basics so you have all the information you need to start trading currency on the Forex market.
On the Forex market the value of one particular currency is always quoted as relative to another (like pounds and dollars), as one currency weakens the other will grow in strength. It is this logic that lies at the heart of forex trading and part of what makes it so popular as theoretically there is always money to be made somewhere.
Currency is always traded in pairs such as EUR/GBP (Euro/Great British Pound). The first currency in the pair is known as the ‘counter’ currency and the second, the ‘base’ currency.
The idea is to buy one currency and sell the other, hopefully making a profit when its value either increases or decreases.
Forex trades are made in incremental lots starting at 10,000 and rising to a maximum of 100,000 in your chosen currency. These lots represent the size of your bet or ‘position’, although they don’t represent the full value of your trade. Instead you deposit a percentage of your ‘position’ in an account which is known as the ‘initial margin ’.
The initial margin you will be required to deposit varies from broker to broker, but typical figures are between 1 and 2.5% of the position . This means that if your position totalled £20,000 and your initial margin was 1% then you would be required to keep £200 in your account. However, you should be aware that in reality your initial margin may have to be as high as 5% or 10% if you incurred a particularly heavy loss.
It's important to realise that by trading on margin, you are at risk of losing more than your initial investment. Bear in mind, that the smaller the margin you trade on, the more you will lose if the market turns against you.
Forex Spread Betting
As the name implies, Forex spread betting is basically a bet on whether a currency will rise or fall over a certain period of time. Typically the bet is placed on the number of ‘points’ that the currency moves by.
For example: if you place a £2 bet on a currency that moves by 14 points in your favour over a set period of time then your return will be £28.
Unlike dealing in stocks and shares, spread betting on Forex is classified as gambling and thus is exempt from both tax duty and UK capital gains tax.
Another way to trade on currency movements is through the use of Contracts for Difference or CFDs.
CFDs work in a similar way to spread betting, in that they are agreements to pay out the difference between a start and an end price.
CFDs allow you to trade in currency without having to actually buy it, although you will be required to pay between 10 and 25% of the actual value of the currency you trade. However, unlike spread betting you will have to pay capital gains tax on any money that you make.