Foreign Exchange Swaps - Profiting As The Exchange Rate Moves Up And Down
Since foreign exchange swaps always involve the purchase of one currency and the sale of another it is possible to profit whether the exchange rate moves up or down. The secret is simply to buy and sell the right currency at the right time.
The easiest way to understand just how you can profit from foreign exchange swaps as the exchange rate moves up and down is to look at an example of each. Let's start by considering how you might profit when exchange rates move up.
Let's assume that you believe that the UK Pound is going to rise against the US Dollar and that you can currently buy GBP/USD at 1.9340. Let's also assume that you are trading in standard interbank lots of 100,000 so that 100,000 UK Pounds will currently cost 193,400 US Dollars.
In essence to open a trade for a standard lot you will need to borrow 193,400 US Dollars and this amount will need to be repaid when you close out your position. We won't digress from the purpose of this article to discuss the concept of borrowing to fund Forex purchases but, suffice it to say, that the majority of trading is done using borrowed funds making use of the ability to use leverage when Forex trading.
Now let's assume that your belief that the UK Pound would rise against the US Dollar is correct and that the price moves 100 pips to a rate of 1.9440. The 100,000 UK Pounds which you purchased are now worth 194,400 US Dollars and can be sold to repay the original borrowing, leaving you with a profit of 1,000 US Dollars.
In reality it's not quite this simple because there will be costs involved in this transaction, but this does demonstrate the principle of profiting when the exchange rate moves up.
Now let's turn our attention to profiting when the exchange rate moves down.
Let's assume that you believe that the UK Pound is going to fall against the US Dollar from its present rate of GBP/USD = 1.9340. In other words, you believe that the UK Pound is going to buy fewer US Dollars.
In this case you will place an order to sell 100,000 UK Pounds at a cost of 193,400 US Dollars. In other words you will borrow 100,000 UK Pounds and sell them for 193,400 US Dollars.
Again we will assume that your belief was correct and that the rate drops by 100 pips to GBP/USD = 1.9240. At this point you close your position by buying back and repaying the 100,000 UK Pounds which you originally sold which will now cost you 192,400 US Dollars, leaving you with a profit of 1,000 US Dollars.
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