If you watch the business news reports or read the business papers, then you know all about currencies going up, currencies going down, and what those changes do the economy and the market for certain goods. When a country’s foreign exchange (forex) rate increases, the amount of goods they export will decrease, because the goods they are selling to other countries suddenly become more expensive. It also means that the amount of goods they import will increase, because commodities from other countries will be cheaper. When the forex rate decreases, the opposite effect happens. The imports will decrease and the exports will increase (in economic terms, this means that a country’s “terms of trade” has improved).
All of this matters a lot in terms of the macroeconomic policies for a country, and when a company produces a good that is very sensitive to import or export fluctuations (these are called “import competing” and “export competing” goods), forex rate changes have a serious impact on the business. But what does all of this mean to you, personally? Does the foreign exchange rate really matter all that much in terms of how much cash you have in your pocket? Even better, is there a way you can make money from forex fluctuations? The good news is that you can sit back and make money from the forex rates without selling a single good or without really even investing much time. All you have to do is make money on buying and selling currency as the rates change.
In economics, the process through which you can make money in a forex enterprise is called triangular arbitrage. The way it works is simple. Say you know that 1 US dollar is equivalent to 2 Pounds Sterling, and you know that 2 Pounds Sterling buys you 4 euros. However, you also know that the exchange rate between dollars and euros hasn’t caught up yet, and that 1 US dollar equals 5 euros. In this case, you would want to take your dollars, buy euros and then use your euros to buy Pound Sterling. You’ll be making a profit on the Pound Sterling you purchase because the exchange rate between those two currencies is 2 Pounds equals 4 euros (or 4 euros buys 2 Pounds) – but since you’ll have received 5 euros for every dollars instead of the 4 the cross exchange rate implies, you’ll be making a profit. The profit here is small with these numbers, but if you move a large amount of currency in this way, your profit can be substantial.
People who profit from forex enterprises like triangular arbitrage have to be on top of their game. As many people engage in these kinds of transactions, the exchange rate discrepancies will be reduced, and your profit will disappear. Likewise, you have to watch for signs that exchange rates are going to rise and fall due to other factors. If you have a knack for predicting the market and a familiarity with some principles of forex, however, there could be major money waiting for you.