Calculating Forex Profits and Losses.

A Guide To Calculating Forex Profits and Losses.
By David Shephard

The first thing that the newcomer to the world of Forex needs to realize is that in Forex trading currencies are traded in much smaller divisions than is the case for normal cash transactions. Although the smallest cash division in the US is the penny (US $0.01), US currency can be traded on the Forex market in divisions of as low as US $0.0001. This smallest division is known as the pip, which is short for Price Interest Point and is also sometimes referred to as 'points'.

As currencies are traded in large lots (typically US $100,000), small movements in the value of the currency can produce substantial profits and losses. For example, in a lot of US $100,000 one pip is worth $10 so an increase of just 40 pips (or 4/10 of one cent) can generate a profit or loss of US $400.

Although the standard lot in Forex trading is 100,000 units of the base currency, currencies can be traded in lots of various sizes. When talking about a lot, the term ‘unit' is the currency name, so that for the US dollars one unit is one dollar.

Different currencies also have different sized pips. The US dollar, for example, is expressed in pips of 0.0001 while the Japanese yen is expressed in pips of 0.01. The value of a pip will depend on the currency pair being traded and the size of the lot. Currency pairs involving the US dollar (USD) with USD as the quote, or second, currency (for example CAD/USD) always have a pip value of $10 for a standard lot. For other currencies a pip value calculator should be used.

There are various different types of order that can be placed by a Forex trader and these order types will have an effect on the profit of loss made in each transaction.

Market Order. A market order is an order to buy or sell at the current market price and be used to either enter or exit a trade. Market orders need to be used carefully because, in fast-moving markets, there can be a significant difference between the price displayed at the time a market order is made and the actual price when the transaction is made. This gives rise to slippage, which is the amount by which the market moves in the time (often just a few seconds) between placing an order and its execution. Slippage can result in a gain or loss of several pips.

Limit Order. A limit order is an order to buy or sell when a certain limit is reached. Limit orders are often used to either buy a currency below the market price or to sell a currency above the market price. If you are buying, your order is executed only when the market falls to the price stated in your limit order. Similarly, if you are selling, your order is executed when the market rises to the price specified in your limit order. In the case of limit orders there is no slippage.

Stop Order. A stop order is an order to buy above the market or to sell below the market. They are most frequently used as stop-loss orders to limit losses if the market moves against the trader's expectation. A stop-loss order will sell the currency if the market falls below the point set by the trader.

One Cancels the Other (OCO). An OCO order is used when placing a limit order and a stop-loss order at the same time and simply means that if either order is executed the other is cancelled. This is useful as it allows a trader to make a transaction without having to monitor the market. Should the market fall, the stop-loss order will be executed, but if the market rises to the level specified in the limit order, the currency will be sold at a profit.

Here is an example of an OCO Transaction:

Buy: 1 standard lot EUR/USD @ 1.3248 = $132,480

Pip Value: 1 pip = $10

Stop-Loss: 1.3223

Limit: 1.3348

This is an order to buy US dollars at 1.3348 and to sell them if they fall to 1.3223 (resulting in a loss of 25 pips or $250) or to sell them if they rise to 1.3348 (resulting in a profit of 100 pips or $1,000).

Let's look at another example:

The current bid/ask price for US dollars and Canadian dollars is

USD/CDN 1.2152/57

This means that you can buy $1 US for 1.2152 CDN or sell 1.2157 CDN for $1 US.

Now, if you believe that the US dollar is undervalued against the Canadian dollar, you will buy US dollars (at the same time selling Canadian dollars) and wait for the US dollar to rise.

Here is the transaction:

Buy USD: 1 standard lot USD/CDN @ 1.2157 = $121,570 CDN

Pip Value: 1 pip = $10

Stop-Loss: 1.2147

Margin: $1,000 (1%)

In this standard lot transaction you are buying US $100,000 and selling CDN $121,570. If the price of the dollar falls below then your stop-loss order will be executed and you will lose $100.

However, let's assume that the USD/CDN rises to 1.2192/87. You may now sell US $1 for CND $1.2192 or sell CDN $1.2187 for US $1.

Because you entered the transaction by buying US dollars, you must now sell US dollars and buy back Canadian dollars to realize your profit. So, you sell US $100,000 at the current USD/CDN rate of 1.2192, and receive CDN $121,920 for which you originally paid CDN $121,570. Your profit is CDN $350 or US $287.19 (350 divided by the current exchange rate of 1.2187).

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