Making profit from currency movements

As investor, your goal in Forex trading is to profit from foreign currency movements. In my first post about the FX market, I already mentioned, that currency trading is always done in currency pairs. For example, the exchange rate of EUR/USD on Aug 25th, 2003 was 1.0857. This number is also referred to as a "Forex rate" or just "rate" for short. If the you had bought 1000 euros on that date, he would have paid 1085.70 U.S. dollars. One year later, the Forex rate was 1.2083, which means that the value of the euro (the numerator of the EUR/USD ratio) increased in relation to the U.S. dollar. You could now sell the 1000 euros in order to receive 1208.30 dollars and make USD 122.60 profit.

(cross rates: 2010-11-11, 12:57 UTC, source: www.xe.com)

However, to know if the investor made a good investment, one needs to compare this investment option to alternative investments. At the very minimum, the return on investment (ROI) should be compared to the return on a "risk-free" investment. One example of a risk-free investment is long-term U.S. government bonds since there is practically no chance for a default, i.e. the U.S. government going bankrupt or being unable or unwilling to pay its debt obligation.

When trading currencies, trade only when you expect the currency you are buying to increase in value relative to the currency you are selling. If the currency you are buying does increase in value, you must sell back the other currency in order to lock in a profit. An open trade (also called an open position) is a trade in which a trader has bought or sold a particular currency pair and has not yet sold or bought back the equivalent amount to close the position.

However, it is estimated that anywhere from 70%-90% of the FX market is speculative. In other words, the person or institution that bought or sold the currency has no plan to actually take delivery of the currency in the end; rather, they were solely speculating on the movement of that particular currency.