If you have learned forex online currency trading, then you know the basis principle of forex currency trading is actually pretty simple. Making money through foreign exchange could be as easy as buying one currency for a cheaper rate and selling it at a more expensive rate. I could buy Euros at a rate of 1.5 USD per Euro, and sell them at 1.52 USD per Euro. This would enable me to earn 2 cents per Euro I sell. It’s usually the money changers who make money this way, but speculators and traders also make money using this method.
Speculators and traders usually preempt or predict market fluctuations and trade currency accordingly. For instance, if a speculator has inside information that demand for a certain currency will increase in the next few weeks, he can infer that the increased demand might strengthen that currency. So the speculator buys up a lot of that currency before the exchange rate increases. When the exchange rate has increased to a level where the speculator feels he can maximize his gain, he may opt to sell the currency he has in reserve and make a profit out of it.
This may seem like a good way to make easy money, but it is also a fast way of loosing money. The forex currency market is a very unpredictable market, sometimes involving several unlikely factors such as the weather to the disposition of the head of state. It is also fairly easy to make a miscalculation or to misinterpret the warning signs of the currency market, not to mention difficulty in predicting the market reactions correctly.
A speculator may also make mistakes by short selling. Short selling involves selling something that is not currently in possession of the seller but he plans to buy it in the future when the price goes down. Many people were bankrupted by short selling, especially at the onset of stock market crises.
A person would gamble on the fact that the exchange rate for the currency they are trading will fall shortly, so he would promise a certain amount of the currency he is trading at the standing exchange rate. If the rate falls the next day, he would purchase the currency at a lower price and make a profit out of the difference. Yet unforeseeable circumstances such as wars or stock market crashes of debt defaults might cause the value of the currency to rise really high or to drop really low.
If the currency the trader promised to provide his client suddenly fluctuates, the trader loses a lot of money since he has to buy the currency at the current inflated rate instead of the low rate he expected.
Entering into forward contracts can also make money. Forward contracts are agreements to exchange goods (in this case, money) at a rate agreed upon today, at a future time. A person might need a certain amount of money, say Euros, in a year’s time, but he is not certain whether the current dollar-to-euro exchange rate would hold after a year because of the weakening dollar. So he enters into a forward contract with another person or institution, where he agrees to pay a certain amount of money in dollars after a year, by when he will get the amount of money he wants in euros.
Forwards contracts usually form a sort of safety net for currency fluctuations and uncertain financial markets by assuring the buyer that he will pay the amount of money he needs at an exchange rate he is willing to pay. Of course, if the dollar strengthens in the next year, the client might wish he had not entered into the contract, but if the dollar continues to fall he might well be patting himself in the back for being smart.