Imagine that we have decided to go long, using a currency pairing of EUR/USD.
In the following example, there is substantial market tension in regards to forthcoming US GDP figures. In addition, there is an election coming, in which the favourites are a party that is generally considered to be antagonistic in its approach regarding major corporations. However, the economic situation in the Euro zone appears to be quite stable.
Taking this information into account, we come to the conclusion that the Euro will get stronger in relation to the dollar. We therefore go long on EUR/USD, at a bid/ask rate of 1.6774/1.6780. By using the maximum leverage rate of 200:1 we ‘buy’ €10,000 at the level of 1.6780.
So how big does our initial deposit have to be to allow us to complete the trade? It’s worked out like this:
(The total amount we want to buy) x (counter currency exchange/leverage scale)
In this instance that equates to 10,000 x 1.6780/200 = €83.90
So the total amount that we deep to initially deposit to make the trade is just €83.90. The trade goes as we expect and the Euro gets stronger against the dollar. The bid/ask rate moves to 1.6821/1.6827 and we feel that it’s time to close the trade. We sell our €10,000 at the rate of 1.6821.
Remember, we bought at 1.6780, so having sold at 1.6821, we have seen a rise of 41 percentage points.
So how much profit did we make? It’s worked out like this:
(Level sold at) - (level bought at) x (amount we bought)
Which in this instance is 1.6821 - 1.6780 x 10,000 = $41
If however, the markets had moved in the opposite direction to which we expected and the dollar got stronger against the Euro, we would incur a loss. The bid/ask rate moves to 1.6730/1.6736 and we decide to cut our losses and sell our €10,000.
Our losses are worked out like this:
(Level we bought at) - (level we sold at) x (amount we bought)
Which works out as 1.6780 - 1.6730 x 10,000 = $50