Mutual funds, pension funds, and money market funds use the Forex market to invest in foreign markets. They exchange their dollars for a foreign currency and then invest in the foreign country. In a perfect world this type of investment can offer two opportunities for profit. If the dollar falls in value against the foreign currency, the fund would make a profit. If on top of that the foreign investments appreciate, the fund would make even more money.
Unfortunately, most individual investors don't have hundreds of millions of dollars to invest around the globe. For individuals to capitalize on the fluctuating exchange prices they need to take advantage of the leverage available to them. In most cases, leverage of 100:1 is available. To illustrate the power of leverage let's look at a sample trade.Let's say we feel the dollar is going to appreciate against the yen. We have $10,000 available that can be leveraged 100:1. We are very confident in our assessment and decide to fully leverage the account. To execute the trade we would then need to sell yens and buy dollars. The USD/JPY pair is quoted at 105.10/14, meaning you can buy $1 for 105.14 Yen.With full leverage we would purchase $1,000,000 and sell 105,140,000 Yen. As expected, the dollar appreciated in value and the quote changed to USD/JPY 106.25/29. Since we are long the dollar and short the Yen we need to sell dollars for Yen. We can now sell our $1,000,000 for 106,250,000 Yen. We made a profit of 1,110,000 Yen. To calculate your profit in dollars, simply divide by the exchange rate. In this case we would have made $10,447, or 104 percent.
