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With a daily volume of $6.6 trillion, foreign exchange is the largest financial market in the world.
Arranged as a decentralised
for currencies, FX trading offers unparalleled opportunities for informed traders and investors.
As a Forex trader, among other things, knowing the process behind calculating profits and losses is vital.
Currency Pairs: The Basics
The Forex market functions through currency pairs, a quotation displaying two currencies. On MetaTrader trading platforms, currency pair quotes can be viewed in the Market Watch feature (Ctrl+M), offering real-time bid and ask prices. The bid price displays willing buyers – a trader’s selling price. The ask price (or sometimes referred to as the
price) is the price of willing sellers – a trader’s buying price. The spread between the two prices is known as the bid/ask spread, which is typically the broker’s commission.
EUR/USD (Euro / US dollar) is a widely traded currency pair. According to the 2019 Triennial Central Bank Survey of FX and OTC derivatives markets, the US dollar and euro take the lion’s share in terms of turnover.
The euro, in the case of EUR/USD, represents the
currency (the first currency listed); the US dollar is known as the
quote, currency. The base currency in all currency pairs always represents 1 unit. The quote currency indicates the value, or the
cost, to purchase the base currency. For example, EUR/USD trading at $1.2256 means to purchase 1 euro in USD costs 1.22 USD (rounded).
A retail trader entering long EUR/USD is effectively
the euro will advance against the US dollar. Assume the exchange rate for EUR/USD is $1.2160
at entry. If this value rises to $1.2170
this represents a 10-pip gain. A decline to $1.2150, on the other hand, represents a 10-pip loss. Conversely, a retail trader entering a short position in EUR/USD is
the euro will decline vs. the dollar.
Understanding Pip Value and Position Size
A pip, or
price interest point, measures the currency pair’s fluctuation, equal to 1/100th of 1%. Most currency pairs are usually priced to four decimal places (0.0001). Currency pairs containing Japanese yen (JPY) are priced to two decimal places (0.01).
Position size refers to units traded. In other words, the notional value of the position, often referred to as
lots. Don’t confuse this with leverage. Leverage is a fixed ratio offered by the broker; it allows you to trade a position size greater than your account equity. Opting for higher leverage allows the trader to deposit less initial margin, or
a smaller amount of capital; conversely, lower leverage requires a greater amount of initial margin. The bottom line is altering leverage does not change the number of lots (position size), it affects how much of your account equity is used to open a position, the initial margin.
In Forex, most brokerages offer micro, mini and standard lots. A micro lot refers to 1,000 units of the
currency, a mini lot 10,000 units and a standard lot 100,000 units.
While many traders use a pip value calculator, below is the manual calculation for pip value:
quote currency is the same as the account currency
(USD, for example), pip values are 0.10 USD each pip movement for a micro lot. A mini lot (10,000 units) equals 1.00 USD per pip and a standard lot (100,000 units) represents 10.00 USD per pip.
account currency is the same as the base currency, the pip value is found by dividing one pip (0.0001) by the currency pair’s rate and multiplying this value by the lot size (units traded).
account currency is not included in the currency pair, this involves effectively switching the account currency to the base currency of the currency pair you wish to trade. As an example, a trader with an account denominated in GBP that wishes to trade CAD/CHF must locate the rate for GBP/CHF. The trader can then perform the same calculation as demonstrated above using the GBP/CHF rate (the account currency now represents the base currency).
Forex Trading: Profit and Loss
By understanding pip value and position size, you’re able to calculate the profit and loss of a position. However, to obtain a final profit/loss value, you must factor in swap rates (if open positions are left active overnight [beyond 5pm EST]) and commissions.
Another important point to understand is a winning or losing trade is unrealized profit/loss (potential
profit or loss) if the position has not been liquidated. You must close a position to realise profit or loss in your trading account. It is then you may calculate the profit or loss.
Profit and Loss Calculation:
calculation involves multiplying the position size (units traded) by pip movement, or simply multiplying the pip value by pip movement. While many prefer the ease of a Forex calculator, understanding the dynamics behind the calculation is important.
If the quote currency is the same as the account currency (USD).
Imagine EUR/USD increased to $1.2180 from $1.2160: a 20-pip gain. Since a standard lot size in Forex is 100,000 units, if you had bought 3 lots and closed the position, you made 600 USD (300,000 x 0.0020). Another way to calculate this is by multiplying the pip value by the price movement (30 USD x 20 pips).
If you entered 3 mini lots (30,000 units), the same price movement nets 60 USD (30,000 x 0.0020 or 3.00 USD [pip value] x 20 pips). EUR/USD dipping 30 pips in the same position, a loss of 90 USD would be realised.
An account currency denominated in
trading the EUR/USD.
Using the same EUR/USD exchange rate, assume a 50-pip rally lifts the currency pair from $1.2160 to $1.2210. The pip value for 1 standard lot is 8.22 EUR. Therefore, multiplying the pip value by price movement (8.22 EUR x 50) equals 411 EUR profit.
You can also multiply the trade size (in euros [100,000 / 1.2160) by pip movement (82,240 x 0.0050).
An account currency not included in the currency pair (GBP) – assume the GBP/USD rate is $1.3532.
Again, using the same EUR/USD rate as above, a rally from $1.2160 to $1.2190 equals a 30-pip move. The pip value for 2 mini lots is 1.48 GBP. Therefore, a 30-pip gain or loss equates to approximately 44 GBP (1.48 GBP x 30).
You may also calculate profit/loss by multiplying trade size (in GBP [20,000 / 1.3532]) by pip movement (14,779 x 0.0030).
The information contained in this material is intended for general advice only. It does not take into account your investment objectives, financial situation or particular needs. FP Markets has made every effort to ensure the accuracy of the information as at the date of publication. FP Markets does not give any warranty or representation as to the material. Examples included in this material are for illustrative purposes only. To the extent permitted by law, FP Markets and its employees shall not be liable for any loss or damage arising in any way (including by way of negligence) from or in connection with any information provided in or omitted from this material. Features of the FP Markets products including applicable fees and charges are outlined in the Product Disclosure Statements available from FP Markets website, www.fpmarkets.com and should be considered before deciding to deal in those products. Derivatives carry a high level of risk; losses can exceed your initial payment. FP Markets recommends that you seek independent investment advice. First Prudential Markets Pty Ltd trading as FP Markets ABN 16 112 600 281, Australian Financial Services License Number 286354.
How to Calculate Profit in Forex Trading
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