Learn the Basics of Forex Trading

Understand the ins and outs of currency trading and get a handle on the forex market.

Calculating Profit and Loss

For ease of use, most online trading platforms automatically calculate the P&L of a trader's open positions. However, it is useful to understand how this calculation is formulated.

To illustrate a forex trade, consider the following two examples.

1st example: Let's say that the current bid/ask for EUR/USD is 1.4616/19, meaning you can buy 1 euro for 1.4619 or sell 1 euro for 1.4616.

Suppose you decide that the Euro is undervalued against the US dollar. To execute this strategy, you would buy Euros (simultaneously selling dollars), and then wait for the exchange rate to rise.

So to make the trade to buy 100,000 Euros you pay 146,190 dollars (100,000 x 1.4619). Remember, at 2% margin (50:1 leverage), your initial margin deposit would be approximately $2,923 for this trade.

As you expected, Euro strengthens to 1.4623/26. Now, to realize your profits, you sell 100,000 Euros at the current rate of 1.4623, and receive $146,230.

You bought 100k Euros at 1.4619, paying $146,190. Then you sold 100k Euros at 1.4623, receiving $146,230. That's a difference of 4 pips, or in dollar terms ($146,190 - 146,230 = $40).

Total Profit = US $40.

2nd example: Now from the example above, let's say that we once again buy EUR/USD when trading at 1.4616/19. To buy 100,000 Euros you pay 146,190 dollars (100,000 x 1.4619).

However, Euro weakens to 1.4611/14. Now, to minimize your loss you sell 100,000 Euros at 1.4611 and receive $146,110.

You bought 100k Euros at 1.4619, paying $146,190. You sold 100k Euros at 1.4611, receiving $146,110. That's a difference of 8 pips, or in dollar terms ($146,190 - $146,110 = $80)

Total Loss = US $80.