Buying and
Selling
You buy a currency rate if you expect the first-named currency to strengthen against
the second-named currency. When you buy a currency rate you are buying the first-named
currency and paying for it in the second-named currency. The market convention is to
describe this transaction as buying the first-named currency and selling the second-named
currency, and this terminology will be used in the rest of this Guide.
You sell a currency rate if you expect the first-named currency to weaken against
the second-named currency. When you sell a currency rate you are selling the first-named
currency and buying, in other words receiving, the second-named currency.
When you take a speculative foreign exchange position it is the market convention to
buy or sell some round amount of the first-named currency. If, for example, you thought
that the Deutschemark was going to fall against the dollar, you would buy some round
amount of dollars, say $500,000, against the DM.
Profit and loss
To work out your profit or loss on a foreign exchange transaction you need to be
able to work out your position in the second-named currency. (You know your position in
the first-named currency because you specify it when you deal). To work out your position
in the second-named currency, simply multiply your position in the first-named currency by
the rate at which you deal.
Here are two examples which show exactly how profits and losses are made on foreign
exchange transactions:
Example I
You buy $500,000 against the Deutschemark at 1.7500. The market moves in your favour
and you close the position at 1.7700.
Opening transaction:
You buy $500,000 against the mark at 1.7500
| So you: |
| Buy |
$500,000 |
| Sell |
Sell DM 875,000
(500,000 multiplied by 1.7500) |
Closing transaction:
You sell $500,000 against the mark at 1.7700.
| So you: |
| Sell |
$500,000 |
| Buy |
DM 885,000
(500,000 multiplied by 1.7700) |
Result:
| Dollar balance: |
| Opening - you bought |
$500,000 |
| Closing - you sold |
$500,000 |
| Balance |
0 |
| Deutschemark balance |
| Opening - you sold |
DM 875,000 |
| Closing - you bought |
DM 885,000 |
| Balance |
DM 10,000 |
Your dollar balance is zero; you have made or lost nothing in dollar
terms. This is because you sold the same number of dollars as you bought.
Your Deutschemark balance is plus DM10,000. You only had to sell DM875,000 for your
dollars when you opened the transaction and you bought DM885,000 when you closed it. So
you have made a profit of DM 10,000.
Note that your profit is an amount of Deutschemarks, not an amount of dollars.
Example II
You sell ?250,000 against the dollar at 1.5760. The market moves against you and you
close your position at 1.5790.
Opening transaction:
You sell ?250,000 against the dollar at 1.5760.
| So you: |
| Sell |
?250,000 |
| Buy |
$394,000
(250,000 multiplied by 1.5760) |
Closing transaction:
You buy ?250,000 against the dollar at 1.5790.
| So you: |
| Buy |
?250,000 |
| Sell |
$394,750
(250,000 multiplied by 1.5790) |
Result:
| Sterling balance: |
| Opening - you sold |
?250,000 |
| Closing - you bought |
?250,000 |
| Balance |
0 |
| Dollar balance |
| Opening - you bought |
$394,000 |
| Closing - you sold |
$394,750 |
| Balance |
$(750) |
Your sterling balance is zero; you have made or lost nothing in
sterling. This is because you bought the same number of pounds as you sold.
Your dollar balance is minus $750. When you opened the transaction you bought
$394,000, but you had to sell £394,750 when you closed it. So you have made a loss of
$750.
