Calculating FOREX Profits and
Losses
FOREX currencies are traded in much
smaller divisions than cash. Whereas the smallest division in US cash is the
penny ($0.01), US currency can be traded on the FOREX in divisions of $0.0001.
This smallest division is called the
pip (short for Price Interest Point – sometimes just called 'points'). Since
currencies are traded in large lots of (say) $100,000 - small movements in value
can generate substantial profits and losses. In a lot of US$100,000 one pip is
worth $10 so an increase in 40 pips (4/10 of one cent) can generate a profit or
loss of $400.
Currencies are traded in lots of
various sizes. The standard lot is 100,000 units of the base currency. A unit is
the currency name e.g. one unit of US dollars is the dollar. So a standard lot
of US currency is worth $100,000.
FOREX trades can have lots of various
sizes - a mini lot is 10,000 units, but the most trades are done using standard
lots.
Various currencies have different
sized pips. The US dollar is expressed in pips of 0.0001 while the Japanese yen
is expressed in pips of 0.01. The value of a pip depends on the size of a lot
and the currency pair traded.
Currency pairs with USD as the quote
(second) currency (e.g. CAD/USD) always have a pip value of $10 per standard lot
or $1 per mini lot. A pip value calculator can be used to calculate other
currencies.
Order Types
A trader has at his disposal different
types of orders to make FOREX trades. A clear understanding of each type of
order is necessary to be a successful FOREX trader.
Market Order
– is an order to buy
or sell at the current market price. They can be used to enter or exit a trade.
Market orders should be used with care because in fast-moving markets there may
be a difference between the price seen at the time a market order is given and
the actual price of the transaction. This is due to slippage – the amount the
market moves in the few seconds between giving an order and having it executed.
Slippage could result in a loss or gain of several pips.
Limit Order
– is an order to buy or sell at a
certain limit. They can be used to buy currency below the market price or sell
currency above the market price. When buying, your order is executed when the
market falls to your limit order price. When selling, your order is executed
when the market rises to your limit order price. There is no slippage with limit
orders and are thus strongly recommended especially for new traders.
Stop Order
– is an order to buy above the market
or to sell below the market. They are most commonly used as stop-loss orders to
limit losses if the market moves contrary to what the trader expected. A
stop-loss order will sell the currency if the market falls below the point set
by the trader. Again this type is highly recommended.
One Cancels the Other (OCO)
– this order is used
when placing a limit order and a stop-loss order at the same time. If either
order is executed the other is canceled, allowing the trader to make a
transaction without monitoring the market. If the market falls, the stop-loss
order will be executed, but if the market rises to the level of the limit order,
the currency will be sold at a profit.
Example OCO Transaction:
Buy: 1 standard lot EUR/USD @ 1.3228 =
$132,280
Pip Value: 1 pip = $10
Stop-Loss: 1.3203
Limit: 1.3328
This is an order to buy US dollars at
1.3328 and to sell them if they fall to 1.3203 (resulting in a loss of 25 pips
or $250) or to sell them if they rise to 1.3328 (resulting in a profit of 100
pips or $1,000).
Here's another example:
The current bid/ask price for US
dollars and Canadian dollars is
USD/CDN 1.2152/57
...meaning you can buy $1 US for
1.2152 CDN or sell 1.2157 CDN for $1 US.
If you think that the US dollar (USD)
is undervalued against the Canadian dollar (CDN) you would buy USD
(simultaneously selling CDN) and wait for the US dollar to rise.
This 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%)
You are buying US$100,000 and selling
CDN$121,570. Your stop loss order will be executed if the dollar falls below
1.2147, in which case you will lose $100.
However, USD/CDN rises to 1.2192/87.
You can now sell $1 US for 1.2192 CDN or sell 1.2187 CDN for $1 US.
Because you entered the transaction by
buying US dollars (buying long), you must now sell US dollars and buy back CDN
dollars to realize your profit.
You sell US$100,000 at the current USD/CDN
rate of 1.2192, and receive 121,920 CDN for which you originally paid
CDN$121,570. Your profit is $350 Canadian dollars or US$287.19 (350 divided by
the current exchange rate of 1.2187).
