Apart from trading currency pairs, other methods can also earn a profit
Many people think that you can make money trading forex only by buying currency pairs and selling them at a higher price. The truth is that this is just one way you can use forex trading to make money: there are multiple other options, and we will talk about them in this article.
Aside from directly trading currency pairs, you can also trade instruments related to currencies or currency pairs, such as CFDs, options or binary options.
Using a broker's leverage
Maybe you have noticed that most brokers offer a certain level of leverage for your trades. Depending on various factors, they may offer you a leverage of 1:30, 1:50, 1:100 and so on. While this leverage is not exactly a way to make money, it can help you to boost your profits – or, unfortunately, make losses if not used wisely.
Thanks to leverage, traders can make a satisfactory profit even if they have only £100 available for trading. Let’s assume that there is no leverage and you have £100 to execute trades. If the price moves 3% in your favour, you will make a £3 profit. But if you select a broker who gives you a leverage of 1:50, you will open the position with a value of £5,000 and a 3% move in your favour will bring you £150.
However, don't forget that when using leverage (margin trading), you can increase your profits but you also stand to lose more money than the initial deposit.
Trading currency pairs
‘Trading’ usually means buying something at a low price and selling it at a higher one, so the difference between the buy and sell price is your profit. When this concept applies to trading currency pairs, you can say that you take a long position.
There is also another concept of “short sale,” or when you take a short position. This is when you are able to sell something at a high price and buy it later at a lower price. So the profit here would be the difference between the selling price and the buying price.
To understand how this works, imagine you are in a coffee shop one morning and someone wants to buy your laptop for £800 because their own computer broke down and they need one in a hurry. You agree to sell it. After a couple of hours, they no longer need the laptop but are not able to take it with them – this is where you have the chance to close your short position. You offer to buy the laptop back at £750 and make a £50 profit (£800 minus £750).
While the example simplifies it, the concept works much the same way in the forex market. You basically make a profit by selling a currency pair with the expectation that the price will go down and you will be able to purchase the same currency pair at a lower value later on.
Keep in mind that when trading currencies, you can develop multiple strategies which could bring you profit. One way to directly trade currency pairs is by opening positions in the same direction as the trend (called trend trading), meaning that in an uptrend you will buy the pair while in a downtrend you will sell or short the pair.
Contracts for difference
Another way to make money from the forex market is to trade contracts for difference, or CFDs. CFDs represent a derivative trading instrument and they are available for different types of markets such as stocks, indices, commodities and currencies.
If you decide to trade CFDs, you will have be able to speculate on the movement of an underlying asset, but keep in mind that with CFD you don’t actually own the currency pair in which you hold your position. By trading CFDs, you trade on the difference in the price and make profit accordingly.
How to make money trading forex CFDs
Let’s look at an everyday example. Your friend wants to sell his motorcycle for €500 today, but you believe he could sell it at a higher price tomorrow, so you tell him to wait. Because of the potential uncertainty, you make a contract with him stating that in case the price falls below €500, you will pay him the difference – whereas if the price rises above €500, you will receive the difference (less a small fee because, after all, you don't own the underlying asset).
So, you go to the market the next day and your friend receives an offer of €525 for his motorcycle. As you anticipated the price movement correctly, you will receive €22 profit for yourself while the remaining €3 will be a fee for your friend.
By trading forex CFDs you will make a profit in pretty much the same way, with the difference being that you trade CFDs with a margin. Margin trading means that you need to pay a certain percentage of the contract value (the broker provides the rest).
The position you can take when trading CFDs where the underlying asset is a currency pair is the same as directly trading the currency pair. Accordingly, you will take a long position (buy) if you anticipate a price rise, or you will enter a short position (sell) if you expect a decrease in the value of the currency pair.
Forex options are another derivative instrument through which you can make money with the forex market. Unlike the CFDs, the seller of the option must deliver the underlying asset to the holder of the option if the holder exercises the right.
Can I make money trading forex options?
This would mean that you, as holder, don’t have any obligation to buy or sell the currency pair but, if you decide to do so, the seller is obliged to deliver. So, there are two types of options: the call option and the put option. You will take the call option if you expect a price rise, and lock the price at which you can buy the pair in the future. You will want to hold a put option if you anticipate a price decrease because you will set the price at which you will be able to sell the currency.
For instance, you might set a purchase price for the EUR/USD of 1.10 in anticipation of a price increase. It turns out that you are right and the price indeed increases to 1.20. Because the option gives you the right to buy the EUR/USD pair at 1.10, you decide to activate it and buy the pair at the agreed price. After buying the EUR/USD at 1.10, you can sell it on the forex market for 1.20 and cash in the difference immediately.
If, for some reason, the price moves against you and falls to 1.08, then you will leave the option to expire. It should be noted that irrespective of whether you activate the option, you pay a certain premium to the option seller and this premium is the maximum loss you can have.
Trading forex binary options
Binary options are another way in which you can make money with forex. They gained popularity among traders because of their simplicity and the possibility of making profits in excess of 70%, which is why they are also referred to as fixed-return options.
By trading binary options, you can speculate on the direction of the price movement irrespective of the size of the movement where the basic binary options form is the high/low.
Is Forex trading profitable?
Don't forget that forex trading comes with risk, meaning that you should prepare yourself before you start trading. You need to understand how currency pairs work and which factors affect their values.
Additionally, it would be a good idea to get acquainted with technical analysis indicators and how to use them to your advantage. Also, try to set up good money management in order not to risk all your funds at once.