Foreign exchange trade is all about the buying and selling of currencies with an aim of making profits. The Forex market is risky and it is normal for a trader to have some losses. But the main aim of traders is to make more profits than losses in the market. It is imperative for them to know how to calculate their potential profit or losses of trades since their success in the market is based on that.
Profits are either realised or unrealised. Realised profits are profits made after a trade has been closed. Unrealised profits are profits made but the position has yet to be closed. Profits to be made is fully dependent on whether the trader has entered a trade that is moving in the same direction as the price, especially a trade that is following a trend.
How to Calculate Potential Profit and Loss
There are two prices associated with Forex trading. They are the Bid price and Ask price. The Bid price is the price at which traders sell a currency while the Ask price is the price at which traders buy a currency. In a long position, you buy a currency at the Ask price and close the trade at the Bid price. In a short position, you sell a currency at the Bid price and close the position at the asking price.
To calculate profit and loss, you need to factor in the contract size, the number of lots traded and the number of pips made by price movement.
Assume you have entered a 100,000 EUR/USD position of 1 lot at 1.1620. Then the price moves by 50 pips to 1.1670. To know the profit or loss made, you multiply the lots traded, contract size and the pips made. (1 x 100000 x 0.0050= $500).
Buy trade. If the prices move up, then it will be a profit and in case the prices drop, then the trader will incur a loss. From the example above, if it was a long position, you would have a made a profit of $500. If the prices moved down from 1.1620 to 1.1605 by 15 pips, then you would have made a loss of $150 (1 x 100000 x -0.0015).
Sell trade. If the prices move down, then it will be a profit but if the price rises, then it will be a loss. Still from the example above, if it was a short position and the price moved up by the 50 pips from 1.1620 to 1.1670, then you would have made a loss of $500 (1 x 100000 x -0.0050). However, if the prices moved down from 1.1620 to 1.1600 by 20 pips, then you would have made a profit of $200 (1 x 100000 x 0.0020).
There are advantages of knowing how to calculate the profits and losses for a Forex trader. It helps a trader to estimate the potential profit or loss he/she may make before entering a trade. It also helps a trader to estimate on where to place stop losses and take profits for each trade. Most brokers calculate the profits and losses automatically thus makes it easier for the traders. However, it is better for traders to know the calculations in order to make informed and well thought out decisions before entering a trade.
To learn more about Forex have a look thought our Education Section here.