An Example of a Forex Trade - Pip - Profit & Loss - Lot - Long & Short
If you think that the Euro will rise relative to the U.S. Dollar you would buy one lot of the EUR/USD currency pair.
The EUR/USD is trading at 1.2553 when you buy it.
The EUR/USD is trading at 1.2674 when you sell it.
You bought at 1.2553 and sold at 1.2674 for a profit of .0121 or 121 pips.
Each pip is worth $10 in the 100K account.
121 pips x $10 = $1,210 profit
In FX, you also have the opportunity to short (sell first) a currency pair if you think it will fall in price.
If you think that the Euro will fall relative to the U.S. Dollar you would sell one lot of the EUR/USD currency pair.
The EUR/USD is trading at 1.2659 when you sell it.
The EUR/USD is trading at 1.2523 when you buy it.
You bought at 1.2523 and sold at 1.2659 for a profit of .0136 or 136 pips.
Each pip is worth $10 in a 100K account.
136 pips x $10 = $1,360 profit
While these are profitable examples, remember that ending up on the wrong side of a trade can cost you a lot of money.
Long/Short
First, you should determine whether you want to buy or sell.
If you want to buy (which actually means buy the base currency and sell the quote currency), you want the base currency to rise in value and then you would sell it back at a higher price. In trader’s talk, this is called “going long” or taking a “long position”. Just remember: long = buy.
If you want to sell (which actually means sell the base currency and buy the quote currency), you want the base currency to fall in value and then you would buy it back at a lower price. This is called “going short” or taking a “short position”. Short = sell.
What is a Pip?
Here is where we’re going to do a little math. You’ve probably heard of the terms “pips” and “lots” thrown around, and here we’re going to explain what they are and show you how they are calculated.
Take your time with this information, as it is required knowledge for all Forex traders.
Don’t even think about trading until you are comfortable with pip values and calculating profit and loss.
Pip are the initials of Price Interest Point.
The most common increment of currencies is the Pip.
If the EUR/USD moves from 1.2250 to 1.2251, that is ONE PIP.
A pip is the last decimal place of a quotation. The Pip is how you measure your profit or loss.
As each currency has its own value, it is necessary to calculate the value of a pip for that particular currency. In currencies where the US Dollar is quoted first, the calculation would be as follows.
Let’s take USD/JPY rate at 119.80 (notice this currency pair only goes to two decimal places, most of the other currencies have four decimal places).
In the case of USD/JPY, 1 pip would be .01
Therefore,
USD/JPY:
119.80
.01 divided by exchange rate = pip value
.01 / 119.80 = 0.0000834
This looks like a very long number but later we will discuss lot size.
USD/CHF:
1.5250
.0001 divided by exchange rate = pip value
.0001 / 1.5250 = 0.0000655
USD/CAD:
1.4890
.0001 divided by exchange rate = pip value
.0001 / 1.4890 = 0.00006715
In the case where the US Dollar is not quoted first and we want to get the US Dollar value, we have to add one more step.
EUR/USD:
1.2200
.0001 divided by exchange rate = pip value
so
.0001 / 1.2200 = EUR 0.00008196
but we need to get back to US dollars so we add another calculation which is
EUR x Exchange rate
So
0.00008196 x 1.2200 = 0.00009999
When rounded up it would be 0.0001
GBP/USD:
1.7975
.0001 divided by exchange rate = pip value
So
.0001 / 1.7975 = GBP 0.0000556
But we need to get back to US dollars so we add another calculation which is
GBP x Exchange rate
So
0.0000556 x 1.7975 = 0.0000998
When rounded up it would be 0.0001
You’re probably rolling your eyes back and thinking do I really need to work all this out and the answer is NO.
Nearly all forex brokers will work all this out for you automatically. It’s always good for you to know how they work it out.
In the next section, we will discuss how these seemingly insignificant amounts can add up.
What is a Lot?
Spot Forex is traded in lots.
The standard size for a lot is $100,000.
There is also a mini lot size and that is $10,000.
As you already know, currencies are measured in pips, which is the smallest increment of that currency.
To take advantage of these tiny increments, you need to trade large amounts of a particular currency in order to see any significant profit or loss.
Let’s assume we will be using a $100,000 lot size. We will now recalculate some examples to see how it affects the pip value.
USD/JPY at an exchange rate of 119.90
(.01 / 119.80) x $100,000 = $8.34 per pip
USD/CHF at an exchange rate of 1.4555
(.0001 / 1.4555) x $100,000 = $6.87 per pip
In cases where the US Dollar is not quoted first, the formula is slightly different.
EUR/USD at an exchange rate of 1.1930
(.0001 / 1.1930) X EUR 100,000 = EUR 8.38 x 1.1930 = $9.99734
rounded up will be $10 per pip
GBP/USD at an exchange rate or 1.8040
(.0001 / 1.8040) x GBP 100,000 = 5.54 x 1.8040 = 9.99416
rounded up will be $10 per pip.
Your broker may have a different convention for calculating pip value relative to lot size but whichever way they do it, they’ll be able to tell you what the pip value is for the currency you are trading is at the particular time.
As the market moves, so will the pip value depending on what currency you are currently trading.
How do I calculate profit and loss?
So now that you know how to calculate pip value, let’s look at how you calculate your profit or loss.
Let’s buy US dollars and Sell Swiss Francs.
The rate you are quoted is 1.4525 / 1.4530. Because you are buying US you will be working on the 1.4530, the rate at which traders are prepared to sell.
So you buy 1 lot of $100,000 at 1.4530.
A few hours later, the price moves to 1.4550 and you decide to close your trade.
The new quote for USD/CHF is 1.4550 / 14555.
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 1.4530 and 1.4550 is .0020 or 20 pips.
Using our formula from before, we now have
(.0001/1.4550) x $100,000 = $6.87 per pip x 20 pips = $137.40
Remember, when you enter or exit a trade, you are subject to the spread in the bid/offer quote.
So when you buy a currency, you pay the spread as you enter the trade but not as you exit.
And when you sell a currency you don’t pay the spread when you enter but only when you exit.
Definition of a successful trader is having the ability to do three things:
- Make pips
- Keep pips
- Repeat
If you can repeatedly do these three things, then you’re on your way!
But it’s no cakewalk and the way will be very long and painful.
fvarga
