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.

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.

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 cancelled, 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).

Margins & Rollovers

Margins in the Forex (FX) market, unlike their counterparties in the purchase of equity (Down payment), provide for a performance bond against trading losses. The utilization of margins allows traders to hold a position much larger than their account value (Leverage). This allows for increased profit capabilities & positions while maintaining a constant counterbalance against trading losses even in a highly volatile market.

A Rollover is used for open daily positions; a trader will either pay or earn interest on their positions depending on the established margin and market position. Rollover positions are an inherent part of the Forex (FX) trading so it is imperative to keep track of the costs associated. Interest is paid on the currency that is borrowed, and earned on the one that is purchased. If a trader is buying a currency with a higher interest rate than the one he/she is borrowing, the net differential will be positive – and the client will earn funds as a result. Otherwise, the trader will have to incur a negative rollover and pay as long as the position remains open. (In other words, if you are long (bought) a particular currency and that currency has higher overnight interest rate you will gain and if you are short (sold) the currency with a higher overnight interest rate than you will lose the difference.)

Trading Hours

The trading is open 24 hours a day (Weekdays) - trading begins each day in Sydney, and moves around the globe as the business day begins in each financial center, first to Tokyo, London, and New York. Traders have the ability to transact virtually every hour of the day across the globe allowing for tremendous trading flexibility: A true 24-hour market, the online Forex trading market is unlike any other financial market as investors can immediately respond to currency fluctuations caused by economic, social and political events at the time they occur - day or night.

Time Zone		Local Time		GMT		E.S.T (US)
Sydney Open		8:00 AM		9:00 PM *		4:00 PM *
Sydney Close		5:00 PM		6:00 AM		1:00 AM
Tokyo Open		8:00 AM		11:00 PM		6:00 PM *
Tokyo Close		5:00 PM		8:00 AM		3:00 AM
London Open		8:00 AM		8:00 AM		3:00 AM
London Close		5:00 PM		5:00 PM		12:00 PM
New York Open		8:00 AM		1:00 PM		8:00 AM
New York Close		5:00 PM		10:00 PM		5:00 PM
* Previous Night

Traders may either buy (Long) or sell (Short) a currency pairing based on their position and analysis; this provides for the ability to profit in either an up or down market. If a trader believes that a currency will appreciate in value they will buy that currency and if they believe that the currency will depreciate in value, they will sell that currency (Not unlike a short position in the stock market)

How to avoid making psychological mistakes while currency trading

Amelie Gam is an Internet writer for Forex Trading Plus. She just wrote an interesting article on psychological aspect of currency trading.

According to Amelie, a trader exposes himself/herself to the higher risk of loss when he or she :

- doesn't control human emotions;

- acts upon fear or hope without basing own feelings on real facts;

- exploits other people’s human emotions (people who are constant in their mistakes can not gain success and earn money);

- is not disciplined, doesn't make plans, doesn't follow strategies, doesn't apply mathematical and money management principles;

- doesn't run only profitable trades and doesn't try to cut losses as fast as possible;

- uses rumors and advice without being certain of their authenticity and quality.

To be successful you have to think independently of the majority and stick out from the crowd. Currency trading is safer than other trading methods, but if you want to have an edge over other competitors than try to be wise and research first, study other people’s behavior and choose from them only the best.