How does a Forex trader calculate profits and losses?

Forex offers a challenging and profitable opportunity for well-educated and disciplined investors. But being a risky market, it also calls for traders to be constantly alert with regards to their trading position. Success and failure are measured in terms of profit and loss. A clear understanding of profit and loss is essential for traders as it directly affects the margin balance they have in their trading account. 

Calculating profit and loss

Until you close a position, the profit or loss you may incur remain unrealized. The profit or loss is realized when you close out a trade position. In case of a profit, a trader’s margin balance increases, and in case of a loss, it decreases.

To calculate actual profit and loss is a pretty straightforward process. The two components required to calculate profit or loss is the position size and by how many pips the price has moved. The position size multiplied by the pip movements gives a trader the profit or loss for that trade position.

Everything is best illustrated with an example! So here is a simple example on how a trader can calculate his/her profit or loss:

Let’s say that the current bid/ask for EUR/USD is 1.4618/20, meaning you can buy 1 euro for 1.4620 or sell 1 euro for 1.4618.

Now you speculate that the Euro’s value will increase against the dollar. To execute this strategy, you would buy Euros (while simultaneously selling Dollars), and wait for the exchange rate to rise.

You make the trade and buy 100,000 euros and sell 146,200 dollars

As expected, the Euro rises in value against the Dollar, and the pair quote becomes 1.4626/28. You immediately sell the 100,000 euros you have at the current rate of 1.4626, and get USD 146,260.

Here is the math on how you should calculate profit:

                You bought 100,000 euros at 1.4620, and sell $146,200

                Then you sold 100,000 euros at 1.4626, and receive $146,260.

                The difference here is $146,260-$146,200 = $60 or 6 pips profit.

 

A second example, where you once again buy EUR/USD at 1.4618/20

You buy 100,000 Euros and sell 146,200 Dollars.

Contrary to your speculation, the Euro weakens against the Dollar to 1.1410/12. You notice that the price might go down again, and so decide to close the trade to prevent further loss.

So you sell the 100,000 Euros at 1.4610 and get $146,100.

The difference here is $146,100-$146,200 = $100 or 10 pips loss.

You have incurred a loss of $100 in this scenario.

 

A trader should also take into account the broker commission as it is involved in calculating the actual profit and loss. Usually, the commission is the difference between the bid and ask rate. So in our examples  above.

If EUR/USD is 1.4626/28

You bought 100,000 euros at 1.4620, and sell $146,200

                Then you sold 100,000 euros at 1.4626, and receive $146,260.

                The difference here is $146,260-$146,200 = $60, or 6 pips.

Taking into account broker commission, which is $20, you get a net profit of $60-$20 = $40.

Similarly when you incur a loss of $100, the actual loss taking account broker commission is $100+$20 = $120.

 

Calculating profit and loss is simple enough, but having a clear understanding of how much money is at risk in each trade will enable a trader to make smart decisions and manage risk effectively. When trading on a platform, you will not have to calculate profit and loss manually. Check out the Trust Capital trading platform and open a demo account with USD 100,000 credit to see how profit and loss work in real life trading conditions.

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