COURSE 2 – P/L CALCULATION
What Is Pip
Pip or point is the term used in currency market to represent the smallest incremental move an exchange rate can make. Depending on context, normally one basis point or a pip in the case of EUR/USD and GBP/USD is 0.0001. In the case of USD/JPY, one basis point or a pip is 0.01.
Inter-bank Pricing Protocols
LEX strictly follows the standard inter-bank pricing protocols. Therefore, all currency pairs are displayed in the smallest inter-bank pricing format. We display 5 decimal points in EUR/USD, GBP/USD and others. In the case of JPY based currency pairs, we display 3 decimal points. Because we believe tighter spreads enhance our customers’ trading experience.
Example
LEX EUR/USD price displayed in BID / ASK format 1.35423 / 1.35429
LEX USD/JPY price displayed in BID / ASK format 87.210 / 87.218
Understanding Forex Quotes
Forex quote is displayed in BID / ASK format. Bid is an offer made by an investor, trader, or dealer to buy a security at the price at which a market maker is willing to buy. In other words, the bid is what someone is willing to pay for an asset. Ask is the price a seller is willing to accept for a security, also known as the offer price.
Understanding the Forex quote system is essential to the success of Forex trading. All you need to remember is this. The first currency listed is the base currency and the value of the base currency is always 1.
Example
At 08:32 am, the EUR/USD price is displayed as (bid) 1.35423 / 1.35429 (ask). If a trader wants to buy Euro against the U.S. dollar, he will buy the “Ask” or “Offer” price at 1.35429. If the trader wants to sell the Euro against the U.S. dollar, he will take the “Bid” price at 1.35423. The difference between the bid and ask price is the spread.
What Is A Contract
A contract defines the minimum amount of an instrument buyer or seller must trade. For example, 100,000 per contract means the minimum amount the buyer or seller can trade is 1 contract which is 100,000 units of an instrument.
Margin Based Trading
Trading currencies on margin lets you increase your buying power. Without proper risk management tools, leverage can also amplify your potential loss. At LEX, our customers enjoy the flexibility to trade on higher leverage with full suites of risk management tools such as stop loss and trailing stop. We will use 100:1 or 1% leverage factor in our next example. The price of EUR / USD is still 1.35423 / 1.35429. The contract size is 10,000 base currency.
Example
Followed by the looming U.S. employment report, a trader believes the Euro is going to sore and the U.S. dollar will decline. He buys 1 contract of EUR / USD at 1.35429. The cost of this transaction is as follows:
Required Margin Calculation
1.35429 x 10,000 units per contract x 1% leverage factor = $135.42 US Dollar
Example
At 08:32 am, EUR/USD price is displayed as (bid) 1.35423 / 1.35429 (ask).
At 08:35 am, EUR/USD price is displayed as (bid) 1.35512 / 1.35518 (ask).
At 08:45 am, EUR/USD price is displayed as (bid) 1.35390 / 1.35396 (ask).
In the above example, 3 prices are shown at 3 different time. At 08:32 AM, trade Joe believes the Euro will gain strength after the dim U.S. employment data. He buys Euro against the U.S. dollar at 1.35429. After 3 minutes, the Euro indeed rises against the U.S. dollar. Joe decides to sell the Euro at 1.35512. We assume he trades 1 contract which equals to 10,000 units of base currency. His P/L looks like the following:
P/L = (1.35512 – 1.35429) x 10,000 units per contract = 8.3 pips which is roughly equal to $11.25 USD in PROFIT
Shortly after Joe squares his trade he wants to get in the market again, hoping the Euro will rise further against the U.S. dollar. He buys again at 08:35 AM. After 10 minutes at 08:45 AM, Euro declines fueled by worse than expected European economic data release. Joe decides to sell. Assuming Joe still trades 1 contract. His P/L is as follows:
P/L = (1.35390 – 1.35518) x 10,000 units per contract = -12.8 pips which is roughly equal to $17.30 USD in LOSS