In our last lesson we continued our discussion on the logistics of forex trading with a look at what a pip is as well as fractional pip pricing. In today's lesson we are going to continue our free forex trading course with a look at how to calculate profits and losses in the forex market.
As the forex market does not have a standardized trade size and because many currency pairs are not quoted in terms of US Dollars the method for calculating profits in the forex market is a little more difficult than in many other markets.
Luckily most forex trading platforms list out how much the value of a 1 pip move in the market is on the platform so clients do not have to calculate this themselves. With this in mind lets quickly login to our real time demo trading platforms so we can see where this is listed. If you have not done so already I encourage you to register for a free realtime demo account which can be done above this video if you are watching on InformedTrades.com or in the description section if you are watching on Youtube.
Once in the platform you will see the dealing rates window and in that window you should see two tabs at the top, one that says "advanced dealing rates" and one that says "simple dealing rates". Click the tab that says simple dealing rates, which will switch over to a different looking dealing rates window with a bunch of columns in it. If you scroll over to the right you will see a column that says "pip cost". The numbers listed under this column are the value of a 1 pip move in the market for each currency pair.
To calculate your profit or loss all you really need to do is take that number and multiply it by the number of pips of potential profit and loss you have on the trade, and then multiply that by the number of contracts you are trading. This will give you the total potential profit and loss on the trade in US Dollars.
As an example lets say that I am trading 3 standard contracts of USD/CHF. My profit target on this trade is 100 pips and my stop loss is 50 pips away from my entry price. To get the total dollar amount of potential risk and reward on this trade, I would simply multiply the pip value of USD/CHF which as of this lesson is $9.95 by 100 which would give me $995. This is my potential profit on the trade per 1 contract. As I am trading 3 contracts I would then multiply $995 times 3 which would give me $2985 in potential profit on the trade.
To get my potential loss on the trade I would simply multiply the pip value of 9.95 by 50 which would give me a potential loss of $497.50 for each contract traded. As I am trading 3 contracts I would then multiply that $497.50 by 3 which would give me $1492.50 in potential loss on the trade.
As you will notice if you scroll down the Pip Cost column of the realtime demo trading platform, the value of a 1 pip move in currency pairs where the US Dollar is the counter or second currency in the pair is always $10. This is because, as we have learned in earlier lessons, a currency quote represents how many of the second currency in the pair it takes to buy 1 of the first currency. As we are trading contract sizes of 100,000 of the base currency a 1 pip move in 4 decimal place currency pairs is equal to .0001 * 100,000 which equals $10 in currency pairs where the USD is the second currency in the pair.
As you will also notice for currency pairs where the US Dollar is not the second currency in the pair the value of a 1 pip move in the market varies. This is because in those instances the counter currency is not the US Dollar and therefore the value of a 1 pip move has to be converted back into US Dollars at the current exchange rate.
So for example if we are trading USD/CHF and a 1 pip move in the market is equal to .0001 CHF * 100,000 which gives you 10 CHF. So, as just stated, in order to get the pip value for the USD/CHF currency pair in US Dollars you must then convert the 10 CHF back into US Dollars.
Since the calculations are done for you on the platform we are not going to get into all the math here it is simply important to know that for any currency pair where the US Dollar is the second currency in the pair then the value of a 1 pip move in the market will always be $10. For any currency pair where the US Dollar is not the counter currency, the value of a 1 pip move in the market will vary depending on the exchange rate of whatever currency is the second currency in the pair and the US Dollar.
Thats our lesson for today, in our next lesson we will learn about leverage and something which is known as trading on margin so we hope to see you in that lesson.
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Risk Disclosure: Trading forex on margin carries a high level of risk, and may not be suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to invest in foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with foreign exchange trading, and seek advice from an independent financial advisor if you have any doubts.