Assume you live in Australia and use Australian dollars (AUD).
The principle is exactly the same no matter where you live, or what your primary currency is.
- Let’s say the Australian dollar against the US dollar (AUD/USD) exchange rate is even at 1.0000
- This means 1 Australian dollar is equal to exactly 1 US dollar
- You decide to exchange $100 AUD for $100 USD because you think the US dollar is looking strong
- A week later you find the AUD/USD exchange rate has dropped to 0.9000
- This means the Australian dollar has fallen in value compared to a stronger US dollar, just as you predicted
- An AUD/USD exchange rate of 0.9000 means 1 Australian dollar is only worth 90 US cents, but 1 US dollar is now worth $1.11 Australian dollars
- You decide to swap your $100 USD back into AUD
- The shift in the exchange rate means you will now receive $111 AUD in return for your $100 USD
- You make a profit of $11 AUD (minus transaction costs)