The Forex market is a highly volatile place. Prices can fluctuate wildly and where one day you might find yourself up in profits, the next you can be down. In such an environment, where your only measure of success is whether you make profit or not, it’s crucial to be aware of how your account is performing. One of the easiest ways of measuring this is by looking at your Profit and Loss (P&L).
These days, with online trading platforms that can do everything for you – including automating your trades – there’s little need for you to do any manual calculations. Your Profit and Loss should be clearly displayed on your trading dashboard so you’re always on top of it. Despite this, it’s useful to know how the figure is actually calculated as it will help you understand why your account shows the balance that it does.
Additionally, knowing your P&L balance may also affect the way you trade. For example, if your account balance is healthy you might feel that you’re able to take more risk – the more money you have in your account, the more you have available to trade. Conversely, if your account balance is small you might not be so willing to put it on the line.
The calculation of profit or loss is fairly straightforward – all you need to know is the size of the position and the amount of Pips the price has moved. The equation is as follows:
[Change in Price] * [Position size]
Let’s expand on this:
1. The current Bid/Ask price for USD/AUD is $1.0719/$1.0721.
You believe the USD will rise in value relative to the Aussie, so you want to Buy US$100,000 worth.
2. The amount of this trade would be $107,210 [$100,000 x 1.0721].
If you were to use leverage of 50:1, your actual deposit to open the position would be approximately $2,144 [$107,210 / 50].
3. As expected, the USD strengthens to $1.0734/$1.0736. To take a profit, you Sell $100,000 at the new rate of $1.0734, making a total of $107,340.
4. Your profit is calculated by taking the Sell price and subtracting the Buy price:
[$107,340 – $107,210] = $130
Total Profit = $130
Note: This can also be express in Pips: [1.0734 – 1.0721] = 0.0013 (13 Pips)
Remember, you only profit when the market goes with the direction of your speculation. In the above example, you took a Long position (price increase) and the market went in your favour so you received a profit. If you had taken a Short position (price decrease) in the same market conditions, you would have experienced a loss.
In a different scenario, if you had gone Short and the market also went down, you would have received a profit. Being able to profit whether the market goes up or down is a characteristic of the Forex market.
When considering your total Profit and Loss, you also need to take into account any other fees incurred during the transaction of a trade – most commonly these include conversion fees and brokers fees.
In a world where the bottom line is everything, it’s important to know how that line is calculated and everything that contributes to it.
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