Making money trading Forex involves buying lower and selling higher or selling higher and buying back lower. Using leverage means that you can deposit a smaller amount of money to achieve the same buying power as you would have if you bought and sold the currencies outright.
In this example, Sarah deposits $5,000 into her Forex trading account and nominates the leverage on her account to be 1:100. As a result of leverage, Sarah’s buying power on her $5,000 deposit becomes $500,000. Sarah decides to buy 0.1 lots of the AUD/USD par at a price of 0.99802. Three days later, the price of the AUD/USD is 1.04069 and Sarah decides to close her position. Sarah’s profit is calculated as (1.04069 – 0.99802) 426 pips. As Sarah opened a position of 0.1 lots, she made a profit of $426, or $1 per pip.
Of course, should the AUD/USD have moved against Sarah below the opening price of her trade to a level of 0.97802, Sarah would have incurred a loss on the trade of (0.99802 – 0.95542) 426 pips. As Sarah’s position size was 0.1 lots, she would have incurred a loss of $426 or $1 per pip.
It is important to be aware that when trading Forex you can also incur losses which can be greater than your initial deposit.