How to calculate profits in Forex.As we already know we are trading currencies and we are either going to buy or sell a currency. The equation is very simple, the aim is to exchange one currency for another currency with the expectation that the price will change. If the currency you bought increases in value compared to the one you sold, then you will have made money. Let’s look at this in more detail. Forex quotes are always in pairs. Foreign Currencies are always quoted in pairs, eg such as AUD/USD or USD/JPY. Remember you are trading money and you are simultaneously buying one currency and selling another. That is why they are always quoted in pairs. The following example shows that one British pound will buy you $1.65 USD GBP/USD = 1.6500 The first currency to the left of each pair is called the base currency, while the second one on the right is called the quote currency. Just like some other markets Forex allows you to take trades long (when you want the currency to go up) and short (when you want the currency to go down). When buying (going long), the exchange rate tells you how much you have to pay in units of the quote currency to buy one unit of the base currency. In the example above, you have to pay 1.6500 U.S. dollar to buy 1 British pound. When selling (going short), the exchange rate tells you how many units of the quote currency you get for selling one unit of the base currency. In the example above, you will receive 1.6500 U.S. dollars when you sell 1 British pound. Before we calculate a trade, I want you to cast your mind back to when you last saw a news bulletin where the newsreader quoted your country's currency vs the USD. For example, how many AUD (Australian dollar) buys one USD. If the price was quoted .68 that simply means that .68 US cents would buy $1 Australian dollar. Below is an example of using $10,000 AUD to buy USD at an exchange rate of .68 and then exchanging it back two weeks later at a different price.
Base currency. When we buy or sell a currency it is the base currency that we look at first. For example if you buy EUR/USD this means that you are buying the base currency and at the same time selling the quote currency. So therefore if you believe the EUR (base currency) will rise against the USD (quote currency) you would buy the pair. You would sell the pair if you think the base currency will depreciate (go down) in relation to the quote currency. In all forms of trading there is the bid and ask price. Forex trading is no different. Think of the bid and ask like attending an auction of a house. The owner is going to be asking for a price (the ask) and the people attending the auction are going to offer a bid price (the bid). The bid price is always lower than the ask price. The bid is the price in which the broker is willing to buy the base currency in exchange for the quote currency. This means the bid is the price at which you (as the trader) will sell. The ask is the price at which the broker will sell the base currency in exchange for the quote currency. This means the ask is the price at which you will buy. The difference between the bid and the ask price is of course the spread.
Before we calculate the profit and loss we need to be able to work out what the pip value is worth for the currency pair we are trading. You do not need to work all this out yourself when you are trading, the platform will do this for you and the LTG GoldRock support team will also be there to guide you, but I am sure you will agree that it is vital information you should know before you trade real money with Forex. The increment (each move of the market) is called a Pip. If the EUR/USD moves from 1.3370 to 1.3371, it has therefore moved one pip. A pip is the last decimal place of a quotation. Once you enter a trade how many Pips you make or lose is how you measure your profit or loss. Every currency around the world has its own currency value so it is important for us to understand how to calculate a pip value for the currency we are about to trade. For example where the US Dollar is quoted first, the calculation would be as follows. Some currency pairs go to 4 decimal places and some have just 2. For example USD/JPY (price 116.50) is 2 decimal places however USD/CAD is 4 ( price 1.4750) Let's take USD/JPY rate at 116.50 In the case of USD/JPY, 1 pip would be .01 Therefore, USD/JPY: 116.50 USD/CHF: 1.4250 Now that you know how to calculate the pip value, let's learn how to calculate your potential profit or loss. This example will be using US dollars and Sell Swiss Francs. The bid offered is 1.4425 and the askis 1.4430. This is a 5 Pip spread which is very expensive but not unusual for Brokers to charge traders. Because you are buying US you will be working on the 1.4430 (ask), the rate at which traders are prepared to sell. So you buy 1 lot of $100,000 at 1.4430. A few hours later, the price moves to 1.4450 and you decide to close your trade. The new quote for USD/CHF is 1.4450 / 14455. Since you're closing your trade and you initially bought to enter the trade, you now sell in order to close the trade so you must take the 1.4550 price. The price traders are prepared to buy at. The difference between 1.4430 and 1.4450 is .0020 or 20 pips. Using our formula from before, we now have (.0001/1.4450) x $100,000 = $6.92 per pip x 20 pips = $138.40 Trade with low spreads. Spreads have been common place in Forex trading and it is usually the way in which the broker makes a profit. In layman's terms the broker is marking up the price of a currency to make a small profit when you enter each trade. In most cases instead of charging you a commission they will charge what they call a spread. Don't be fooled if you think your broker is not charging you a commission, you are still paying them the equivalent in the spread they charge. Look at the spread like a few hurdles for you to jump over before you start making any money. The broker buys it for A and you pay E and in between is B,C&D of which would be classed as a three pip spread, standard profit for the broker before you make anything. An average spread can be anywhere between 3 and 5 pips. Which on most platforms if you were to enter a trade position with $500 (50:1 leverage = $25,000) with a 2 pip spread you would be paying the equivalent of $20 dollar brokerage. Example
*The above example is calculated by using a common 3 pip spread using an investment size of $1000. The LTG GoldRock Preferred Brokers rates are the equivalent of only a 2 pips usually on most major currency pairs we trade. They can however change the spreads at any time. Understanding Leverage You are probably asking yourself, how can I invest just $500 and control a position of $25,000 which is a 50:1 leverage? $500 * 50 = $25,000. Well it is quite simple actually. You are essentially giving the broker a deposit, in this case $500 and they are then allowing you to trade $25,000. This is 50:1 leverage. 1:1 leverage would be if you had to come up with the entire $25,000 to place the same position. Think of your broker as a bank who basically advances you $25,000 for the fee of a $500 deposit. Depending on the amount of money you want to trade, the broker will ask you for what is called an initial margin, this is effectively the amount of money you must have in your account to trade the position size you wish. You will then enter into your trading platform the profit target and stop loss target and then enter your trade into the market. If your decision is correct you will receive all of your deposit back plus your profits. If your decision incorrect, the loss will be deducted from the deposit you gave. If your loss exceeds the amount of deposit (in this case $500), the balance of monies you have in your account will be used to cover your loss. If you don't have adequate monies in your account then you will have what is called a margin call where the broker will ask you to top up your account for the difference. Forex is a great market to trade because you can choose the size of the position you wish to trade and are not bound by set amounts as the minimum. Provided you have the initial margin (deposit) in your account, you can trade the amount of money you wish. Some brokers have different margin requirements. One broker might ask that to trade $50,000 you have a minimum of $1000 available in your account, whilst another broker may only require you to have $500. So it is important you are trading with a broker that has both low margin requirements and also low commission fees (the spread). LTG GoldRock customers get both of these advantages. For example, a broker may ask that for every $1,000 you have, you can trade 1 lot of $50,000. (50:1 leverage) So if you have $5,000 they may allow you to trade up to $250,000 of Forex. Example Let's say you open a regular Forex account with $2,000 . You open 1 lot of the EUR/USD, with a margin requirement of $1000. Since you started with $2,000, and have just used $1000 to enter a trade, you now have only $1000 available as margin if you wish to enter another trade before you close out the first. If your losses exceed your margin of $1,000 you will get a margin call. The safe thing to do is to always trade with stop losses and never trade an amount of money that is going to potentially put you in a margin call situation. |
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