HOW AN FX TRADE WORKS
The concept of trading FX is simple, once it is realised that a currency is a commodity whose value fluctuates against another currency. By buying (or selling) a currency, FX Traders aim to earn a profit from the movement in the FX rate. The beauty of FX is that the cost of trading is so low. This means that trades can be transacted for the extreme short term, literally seconds, as well as for a longer duration.
A trader believes that the EUR is about to increase in value against the USD and buys EUR 1 million at 1.5000. Shortly afterwards, the rate is 1.5050, and the trader closes the position for USD 5,000.
EUR 1,000,000 at 1.50 = USD 1,500,000
EUR 1,000,000 at 1.5050 = USD 1,505,000
Difference = Profit of USD 5,000
There are around 170 currencies in the world. However, activity is concentrated into six ‘major’ currency pairs, which account for around two-thirds of the total turnover.
The Majors are:
In FX, one currency is always quoted against another. The base currency is the one that can be thought of as the reference. For instance, in a EUR/USD quote, EUR is the base currency, and the quote defines how many USD it costs to buy. Similarly, in USD/JPY, USD is the base currency and the rate defines how many JPY it costs to buy.
Bids and Offers (Asks)
The bid is the price that the market is willing to pay for a certain FX currency pair. The offer, or ask, is the price at which it is prepared to sell.
For example, in a USD/CHF quote of 1.1650/1.653, the bid is 1.1650, while the offer is 1.1653. Frequently, quotes are abbreviated to just the 'small numbers'. In this case, a phone quote would be 50/53.
The difference between the bid and the offer is known as the spread.
A 'pip' (price interest point) represents the smallest fluctuation in price of a currency pair. For most currencies, the rate is quoted to the fourth decimal place, with USD/JPY the notable exception. A pip represents 1/10,000th, or 0.0001 of the counter-currency. A change of 1 pip for GPB/USD at 1.6319 is 1.6320. The pip for USD/JPY is only quoted to the second decimal point (1/100th, or 0.01).
Profit and Loss Calculations
Most modern platforms, such as MIG’s Trading Station, automatically calculate a trader’s profit and loss (P&L) on open positions. This allows traders to keep track as the market moves. Understanding how these calculations work is crucial for all traders.
The chart below shows a summary of the currency pairs provided by MIG, the lot size of each currency pair and the value of each pip per lot. The P&L examples that follow are derived from this chart:
|Currency Pair||Mini Spread||Standard Spread||VIP/ECN Spread|
|Please note: The spreads quoted above are variable and start from the level specified in the table.|
Profit and Loss Calculations - Examples
Sold 3 lots of EUR/USD at 1.3196 and bought them at 1.3122:
In this example, the client made 74 pips * 3 lots = 222 pips in total profit (as they sold at a higher price than they bought). The pip value for EUR/USD is USD 10, so the total profit = 222 pips * USD 10 per pip = USD 2,220.
Bought 2 lots of USD/JPY at 117.75 and sold them at 117.32:
In this example, the client made 43 pips * 2 lots = 86 pips in total loss (as they sold at a lower price than they bought). The pip value for USD/JPY is 1,000 JPY, and this equals 1000/117.32 (price of USD/JPY when the position was closed) = USD 8.524 approximately, and so the client's total loss = 86 pips * USD 8.524 per pip = USD 733.06.
Sold 2 lots of EUR/GBP at 0.8615 and bought them at 0.8526:
In this example, the client made 89 pips * 2 LOTS = 178 pips in total profit. The pip value for EUR/GBP is 10 GBP and this equals 10 * 1.8500 (assuming that the price of GBP/USD was 1.8500 when the position was closed) = USD 18.50, and so the total profit is 178 pips * USD 18.50 per pip = USD 3,293.