Profit And Loss Calculation in Forex Trading
Posted on February 25, 2008
Filed Under Forex Education |
The cumulative buy and sell of a currency causes the value of your Forex investment to move either up or down. Foreign Currencies are traded in pairs and each currency has its own symbol. For the Euro dollar- it is EUR, Japanese Yen - it is JPY, for the Pounds Sterling - it is GBP, and for the Swiss Franc - it is CHF. Hence, EUR/USD would be Euro-Dollar pair. GBP/USD would be pounds Sterling-Dollar pair and USD/CHF would be Dollar-Swiss Franc pair and so on and so forth.
So how are these currency pairs quoted on the Forex market? The first number is called the bid and the second is known as the offer (or the ASK) price. Take for instance EURUSD, you will see 1.4625/1.4630. The first quote of 1.4625 is the bid price, the price where traders are prepared to buy Euro against the USD Dollar. The second number 1.4630 is the offer or ask price and it is the price traders are prepared to sell the Euro against the US Dollar. You will notice that there is a difference between the bid and the offer price. This difference is known as the spread. Based on the previous EUR/USD quote, you know that 1 Euro is equal 1.4625 US dollar.
The way profit is measured of a currency is by “pips” or point. PIP is the acronym for price interest point. If the EUR/USD moves from 1.4625 to 1.4655 that is 50 pips. A pip or 0.001 is the last decimal place of a currency quotation with the exception of the Japanese Yen and Yen cross rates. A price movement for the USD/JPY from 111.10 to 111.60 will be 50 pips.
For the benefit of Forex Trading newbie, I will proceed to a simple hypothetical Forex Trading investment to show how you can profit in Forex trading. In this example, your pair of currency is the EURUSD. The Forex rate of EUR/USD now is 1.4625, you know that 1 Euro is equal 1,462.50 US dollar. If you buy 10,000 Euros today, you would have paid US$14,625. Two days later, the exchange rate is1.4688, this means that the value of the Euro has increased in relation to the USD. If you decide to sell your 10,000 Euros, you will receive $14,688, which is $63 more than what you have paid a few days ago.
Conversely, if the Forex rate few days later has been EURUSD = 1.4600, the value of your Euro has weaken in relation to the US Dollar. If you sell the 10,000 Euros at this exchange rate, you will receive $1,460, which is $25 less than what you have paid two days earlier.
You may think that the above figure is small and irrelevant. You are wrong if you have this misconception in Forex Trading.
The above example does not take leverage into consideration. You must understand that one of the major advantages in Forex currency is the high degree of leverage provided by most brokerage companies.
In the Forex market, depending on which brokerage firm a trader uses, $1,000 could control $100,000 in currency. Such controlling leverage of 100 to 1 is quite typical of most trading account. Using $1,000 to control $100,000 is also known as “margin”.
With such leverage or margin, a 1% relative change in a currency will equate to about 100% return on investment if the trade is in the trader’s favor. There have been many discussions on the topic of margin or leverage and some argue that high leverage is dangerous. Leverage is a double-edge sword. This is a point for the individual concerned to mange their own risk.
As with other trading instruments, there is always risk involved in Forex Trading. To achieve your short term and long term financial goals in forex Trading, you must manage risk to a level that you are comfortable with and works best for you.
Cheers, Kampai, Proscht^^!!Comments
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[…] Well written article […]
This is a good blog Joon. Also, I like the way your blog is laid out. Good design and everything seems to fit.
Good trading to you
RT…