Forex Trade Calculation
FX Trade Calculation
Many people place FX trades, but most do not have an understanding of the things that are behind it. Before anyone gets into FX trading it is important that they are aware of the components in the margin, calculating the P/L, and the rollover principle. Let us review these areas.
Margin Requirements Awareness
At most FX houses traders are trading on margin and are not doing physical FX trading. The physical FX is where 1 dollar equals 1 dollar in value. With margin trading, you can open a 1 million EURUSD position, with a margin requirement of 1% which is 10,000 Euros. Another example, a 10,000 account balance with a 100,000 position would need 1,000 Euros to keep the position open.
Profit and Loss in Pips
Pips are the smallest price change that an exchange rate can make. We use EURUSD as an example, 1.5280 to 1.5281 is a one pip move. We have USDCAD 0.9955 it moves to 0.9956 also a one pip move.
Let us take an example of profit and loss in pips: Buy 100,000 EURUSD at 1.5100 take profit at 1.5160, 60 pips. You have a stop loss at 1.5070, 30 pips, this is from your entry position.
In pip terms we have here what is called a 2 to 1 ratio, when you go long EURUSD at 1.5100, take profit at 1.5160 and a stop loss at 1.5070.
There are several ways to calculate pip value. Since this is reality based guide we will use the simple way. Let us use the EURUSD example, which is quoted with 4 decimal places, ex. 1.5100, and a nominal value (the amount being traded) of 100,000.
First, count the amount of decimal places that you have and in this example it is 4. Starting from the right, remove 4 numbers from the nominal value (100,000) and you will get the value of each pip. Removing 4 zeros, show us that each pip is 10 Dollars. Remember as we covered earlier, the counter currency USD is used to calculate your profit and loss.
Taking it further, a 60 pip profit (60 x 10 USD) gives you 600 USD, or if you had a 30 pip loss (30 x 10) is 300 USD. When you are using ratio trading in your strategy, it must be that your chance of making a profit is greater than the chance of a loss.
This is something that has given FX traders headaches for many years, but it is not a complicated concept. A lot of people skip the rollover in training but we will address it here.
If you are long EURUSD, you are long Euro and short USD. You are holding Euros and you will earn interest on them. You are also borrowing or shorting USD, therefore you pay interest on what you borrow. The difference in interest is either positive or negative which is your swap.
On the reverse, if you are shorting EURUSD you are short Euros and long USD. You are borrowing the Euros in this case and you are now holding US Dollars. The interest difference is either positive or negative which is the swap.