Stop trades are simply numbers on a screen.
You are literally making bets on whether numbers on a screen will go up or down.
Here’s a helpful analogy.
Let’s pretend there’s a website where you can buy or sell an iPhone.
On this website, the price of the iPhone constantly changes based on how many people are buying the iPhone versus how many people are selling their iPhone.
Technically speaking, if the current iPhone price is $1,000, you could write it as:
iPhone/USD = 1,000
I can exchange 1 iPhone for 1,000 U.S. dollars.
I priced the same thing if the iPhone in euros. If the current iPhone price is €900, you could write it a:
iPhone/EUR = 900
I can exchange 1 iPhone for 900 euros.
In this example, we’ll assume they price the iPhone in U.S. dollars.
They glued you to your computer monitor as you watch the price move up and down.
You’re a devout Android smartphone user and even have a huge green tattoo of the Android logo on your chest, so while you personally hate iPhones, you think the price of the iPhone will continue to rise due to strong demand from irrational Apple fanboys and want to try to make some money on this prediction.
But you don’t want to deal with having to physically buy an iPhone, and then wait for the price to rise, and then have to physically sell it for a profit.
You don’t want to own an iPhone. That would mean having to touch one. The mere thought makes you nauseous.
You just want to make a bet that the PRICE will go up from here.
Now imagine there is a totally separate website where all it does is monitor the price changes of the iPhone from the first website.
Think of this website as a “scoreboard” that simply displays what’s going on on the other website and updates in real time.
But it doesn’t just display the current iPhone price, it also allows you to make bets on whether the price shown will go up or down.
Here’s how the bet works:
For example, you see that the current price is $900. You think the price will go UP from here so you place a bet.
In order for the website to accept your bet, it asks you for a “security deposit” of $100. We need this deposit just in case you’re wrong and the price starts falling.
People who lose bets tend to “ghost” you and disappear rather than paying up. The website wants to protect itself from this risk of dealing with deadbeats.
If the iPhone’s price falls to $800, your bet will automatically be closed and the website will keep the $100 to cover your loss. But if you win, you’ll get the deposit back.
Fortunately, the price proceeds to rise to $1100 and you decide to close your bet.
The website pays you $200, the difference between the price when you opened the bet ($900) and when you closed the bet ($1100).
We also returned your security deposit.
As you can see, when you make a bet on this second website, you’re not actually participating on the first website where the actual buying and selling of the physical iPhones is happening.
You are simply speculating on the price direction. Like a betting game.
You never actually bought or sold an actual iPhone.
Now substitute the scoreboard showing prices of “iPhone/USD” with “EUR/USD” and you now have a good idea of how retail forex trading works!
You are trading a “scoreboard” of FX rates that your forex broker displays to you on its trading platform.
For example, if you think EUR/USD will go up, you click “Buy”.
When you “buy”, you are placing a bet with your forex broker that the PRICE will go up from the current price.
You don’t actually own or take possession of currencies. It’s not like trading stocks, where when you buy Apple, you actually own Apple shares.
When you “buy” or “sell” EUR/USD, you’re not actually buying physical euros or selling physical dollars.
What you’re actually doing is making a directional bet on the exchange rate (or price) itself.
This is done through the use of a financial instrument known as a financial derivative contract (“derivative”).
A derivative is a financial instrument that enables traders to speculate on the price movement (“change in price”) of assets without purchasing the assets themselves.
The value of a derivative is dependent upon or DERIVED from the value of its underlying asset, which can include bonds, stocks, commodities, crypto, or currencies. In this specific example, the underlying asset is EUR/USD.
Because there is nothing physically being traded when derivative positions are opened, they exist as a contract between two parties.
So when you “buy” EUR/USD, your forex broker “creates” (or “issues”) a derivatives contract between itself and you.
This contract is known as a contract for differences (CFD).
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