Currency trading markets became the biggest and most liquid markets in the world, they became also a magnet for speculators that bet on financial derivates and use leverages.
Forex (also known as FX) is one of the most used words in the world of financial traders. Forex is an abbreviation of Foreign Exchange and it represents exchanging foreign currency. Its market is the biggest and most liquid market in the world, where currency pairs are traded. Daily trading volumes of carried out transactions peak over 5 trillion US dollars. Currency pairs EUR/USD, USD/JPY, GBP/USD and USD/CHF belong among the main currency pairs that are traded. Most traded currency is US dollar. The markets are open 24 hours a day, 5 days a week.
With forex trading comes inherently the usage of leverage products and financial derivatives, that enable the traders to use multiplication of their profits. Using contracts for difference (also known as CFD) with leverage effect leads to high profits even when the currency pairs move just a tiny bit. But it also leads to high losses, if the exchange rate moves in the other direction than what the trader expected.
For a better understanding of forex trading using financial leverage, we prepared a model case with real currency pair exchange rate movements. The currency pair will be EUR/USD. We will now watch the movement on 25 July 2019 between 2.15pm and 3.45pm. The investor will use 10,000 EUR of his own capital.
The table shows the comparison of results when using various levels of financial leverage. The investor speculated on price growth.
|A model comparison of CFD trading using financial leverage and the EUR/USD currency pair|
|EUR/USD 25 Jul 2019 2.15pm- 25 Jul 2019 3.45pm|
|leverage||Value at the opening||Value at the closing||Change (in %)||Investment (EUR)||Profit/ Loss (EUR)||Spread (EUR)|
*Charges: the table shows so-called spread, that is a charge of the broker which is calculated from trader’s profit from the difference between buying and selling price. More information about charges and detailed calculations are available in https://gulfbrokers.com/.
Let’s assume that the investor opened a position on 25 July 2019 at 2.15pm, when EUR/USD currency pair had the value of 1.1106 and then closed the position on the same day at 3.45pm when the value was 1.1181. In this time frame the EUR/USD value rose by 0.67 %. The investor speculated in the wrong direction. EUR/USD is growing which means a loss for the investor. In other case, he would gain profits.
When trading with EUR/USD currency pair using CFD, the leverage may be applied up to 1:30, our model shows also the situations and profits/losses when traders use lower leverages or do not use leverages at all. In the last case the investor would end up with a loss of 67 EUR. This loss becomes more substantial with using leverages, since 1:10 in this case creates a loss of 670 EUR. The maximal allowed leverage for retail investors, 1:30, creates a significant loss of 2,010 EUR, which means 30 times higher loss in comparison to not using leverage at all. It is true, that the profits work in the same way. If we changed the investor’s speculation direction, e.g. he would speculate on decrease, the trader would earn 2010 EUR when using maximal allowed leverage.
The broker is prohibited by capital markets trading law to allow these products to everyone, due to high risks connected to CFD trading and other leverage products. The broker must firstly asses experience, financial situation and client’s preferences through investment questionnaire. Based on its result he may offer products from the least risky to most risky. A solid investor with experience should not have any problems with CFD trading authorization.
Robots start to add to the massive spread of online trading
Trading brokering through online platforms is so easy that it destroyed most barriers between individual traders and markets, like forex, that were previously only open to big corporate investors.
But there is still a significant progress ongoing at this easily accessible online trading. “Investment robots” belong among the newest technologies. These robots also trade with forex and create trades automatically instead of the trader. They react to pre-set signals with adjustable risk level. Apart from precision of their work they also have another advantage – they never sleep, which means they can trade in forex markets for all 24 hours a day. They do not yield to tiredness or emotions and save work and effort. Do the robots beat the world’s best investors? Not yet. We should firstly warn everyone from robots, or better said their operators, that promise great profits. All people that have at least basic education of economy know well, that a strategy that is available to everyone cannot bring above‑average profits in long-term to everyone. Human intuition and invention still prevail.