Forex basics: Profit Calculation in Forex Trading

How to Calculate Profit in Forex?

Forex market is a place where you can earn profits despite of the price trend. Trader can make profit when the price increases and when the price decreases. There are two choices when a trader decides to open a position. Traders either buy a currency pair at ask price when he/she thinks the price of the currency pair will increase or sell a currency pair at bid price when he/she thinks the price of the currency pair will decrease. When the price of a currency pair increases, the base currency is becoming relatively stronger than the secondary currency. When the price of a currency pair decreases, the base currency is becoming relatively weaker than the secondary currency.

For instance, let’s consider EUR/USD 1.4620/1.4622

• Base Currency = EUR
• Secondary Currency = USD
• Bid Price = $1.4620
• Ask Price = $1.4622
• 1 pip = 0.0001
• Spread = 2pips
• Leverage = 200:1

Buying a Currency Pair During Uptrend Market

Assume that base on your analysis, you think the price is most likely to go in an uptrend direction. You buy a mini lot ($10,000) of EUR/USD at the ask price of $1.4622. The ask price is 2 pips higher than the actual market price. The price that your broker quotes to you is equal to the ask price. It will be 2 pips higher than the actual market price when you buy a currency pair where 2 pips is the spread of this currency pair. In this case, you are actually buying $1x$10,000=$10,000 of EUR in exchange of $1.4622x$10,000=$14,622 of USD with $10,000/200=$50 (USD) of margin. However, the actual market price is only $1.4520 when you hit the buy button. If you close your position immediately by selling your $10,000 of EUR back to the market at bid price of $1.4620, you only get back $14,620 of USD. This results an immediate loss of $14,620-$14,622=-$2 (USD). Now you have $10,000 of EUR in your hand. You wait patiently for the price to increase. When the actual market price increases to $1.4630, you close your position by selling the $10,000 of EUR in your hand in exchange of $1.4630x$10,000=$14,630 (USD). Therefore, your profit will be $14630-$1.4620-$2=$8 (USD).

Selling a Currency Pair During Downtrend Market

Assume that base on your analysis, you think the price is most likely to go in a downtrend direction. You sell a mini lot ($10,000) of EUR/USD at the bid price of $1.4620. The bid price is equal to the actual market price. The price that your broker quotes to you ($1.4622) will be 2 pips higher than the actual market price when you sell a currency pair where 2 pips is the spread of this currency pair. In this case, you are actually selling $1x$10,000=$10,000 of EUR in exchange of $1.4620x$10,000=$14,620 of USD with $10,000/200=$50 (USD) of margin. However, the actual market price is $1.4520 when you hit the sell button. If you close your position immediately by buying back your $10,000 of EUR from the market at ask price of $1.4622, you will need to pay $14,622 of USD. This results an immediate loss of $14,620-$14,622=-$2 (USD). Now you have $14,620 of USD in your hand. You wait patiently for the price to decrease. When the actual market price decreases to $1.4610, you close your position by buying back the $10,000 of EUR from the market by only paying of $1.4610X$10,000=$14,610 (USD). Therefore, your profit will be $14620- $1.4610-$2=$8 (USD).

Forex basics: Lot Size, Leverage and Margin

Lot Size

There are three types of lot size, i.e. standard lot, mini lot and micro lot.

• Standard lot = 100,000 units of base currency
• Mini lot = 10,000 units of base currency
• Micro lot = 1,000 units of base currency

Margin

Margin is the equity value of your trading account. If you deposited $500 initially, this $500 is your initial margin. It depends on whether you win or lose when you trade, your margin will increase or decrease accordingly.

Leverage

You are not required to pay for the full amount of the lot when you open a trade position. Most of the forex brokers offer leverage of up to 200:1. With a leverage of 200:1, you are only required to pay for 1/200 of the lot amount. For Instance, if you would like to trade with one mini lot, you are only required to pay $10,000/200=$50. Your free margin will be $500-$50=$450 when you open a mini lot position.

Forex basics: How to Read Forex Quotes?

Forex Quotes

The first currency in a currency pair is called Base Currency. The value of the base currency is always 1. The second currency in a currency pair is called Secondary Currency. For instance, EUR/USD = 1.4620 means EUR 1.00 can be exchanged into USD 1.4620.

Pip

Pips, or “percentage in point” is the smallest decimal point in a currency pair. Currency pairs that do not involve Japanese yen have four decimal points. Thus, one pip for currency pairs that do not involve Japanese yen is 0.0001. Currency pairs that do involve Japanese yen have two decimal points. Thus, one pip for currency pairs that do not involve Japanese yen is 0.01.

Bid Price

Bid price is the selling price from trader’s point of view. It is the price that the market is willing to pay for a particular currency pair at the time of trading.

Ask Price

On the other hand, ask price is the buying price from trader’s point of view. It is the price that the market is willing to sell for a particular currency pair at the time of trading.

Spread

Spread is the difference between bid price and ask price.

Let’s look at an example, EUR/USD 1.4620/1.4622. The quote above shows EUR/USD 1.4620/1.4622, which means the bid price of EUR/USD is 1.4620 and the ask price of EUR/USD is 1.4622. The spread is 0.0002 or 2 pips.

Forex basics: Currency Pairs in Forex Trading

A currency pair is made up by two nation's currency code. A nation's currency is recognized by a ISO 4217 international three-letter code. Below are the codes for world leading major currencies.

• USD = US Dollar
• EUR = Euro
• JPY = Japanese Yen
• GBP = British Pound
• CHF = Swiss Franc
• CAD = Canadian Dollar
• AUD = Australian Dollar

Currencies are traded against one another. Therefore, a currency pair is always displayed as XXX/YYY, where XXX and YYY are the ISO 4217 international three-letter code of a nation's currency. Below are the major currency pairs.

• EUR/USD
• USD/JPY
• GBP/USD
• AUD/USD
• USD/CHF

Forex basics: Why Most Traders Fail?

Why most traders fail?
Most of the forex trainer will tell you that data shows 95% of the traders fail. Only 5% making money! I don’t want to discuss the accuracy of that statistics. The fact is that most of the people trade forex like they are playing in a casino. They don't really know how to play the game and they are in the game. Or, they know the rules and regulations of the game; just that they refuse to admit that they are wrong when they are wrong. Below examines some common reasons of why most of the traders fail.

Bad profit and risk management
Do not expect instant huge amount of fast cash flows into your account and always remember that any trading instrument involves risk of losing money. Most of the traders simply forget about it when their emotion comes into play. When they open a losing trade, they refuse to admit that their analysis is wrong and refuse to close the position. Usually they hope that the price will somehow come back to the breakeven level later. As long as the position is open, the mistake simply cost you more and more money. Always trade with the money you can afford to lose and stay away from buying larger volume when you still do not have the skill to win most of your trades.

Too dependent on leverage
Leverage is only there for your convenience. You should never let the thought that higher leverage can make up for a lake of leverage. To a certain extent, leverage is there to attract you, so that you can start contributing your savings to other big player in the market willingly. You just need to understand a simple fact. Leverage is a two edged sword. It can help you to bring

Let emotional involved
Most of the traders get emotional when fail to get profit from a trade. The trading platform suddenly turns into a casino. Traders start to bet on an unpredictable outcome. When you experience few unsuccessful trades, just stop for a while. Think and find out what went wrong. Get yourself a cup of coffee and let your mind cool down before open another position.

Greedy
Another scenario happens when they are in a winning trade. Still, the position is kept open, hoping for extra few pips by waiting a little longer. It feels good seeing the money grow. Most of the traders simply want too much. Always remember, there are only two outcomes when trading. The price either goes up or down. Just close the position if you already reach your target profit level or when your exit indicators give you signal. Follow your trading plan. There are plenty of opportunities around. Why bother about those few pips when you can earn more next time

Overconfidence
Most of the traders simply jump into real money account and high leverage thinking or probably hoping that they will get their money back fast, real fast. Knowing how to trade does not make you a successful trader instantly. Trading needs skills as well as experience. There are other factors that whatever tools or indicators won’t show.

Too many trading system
Maybe this is the opposite of overconfidence. A trader only needs one trading system to succeed. There is no holy grail in forex and other trading market. The indicators used are all lagging indicators. They are plotted base on past data. It is normal that you get into some wrong trade sometime. The important here is to know that you know you are wrong and cut your losses fast. You don’t need to switch from one system to another system. Stick to the one that make sense to you and make you win more trade.

Do not pay attention to market situation
If a trader does not pay attention to market situation, it is like sailing in an ocean without a compass or swimming against the stream in a river. It is definite for a trader to fail if he/she trade without direction and against market force. Therefore, always pay attention to the latest news release about a country's economic perspective, political issues, etc to get a better picture of where the market is going.