Once an investor has selected a currency pair and the direction he wants to trade to enter an exposure, he needs to choose the trade amount.
Speculation in the foreign exchange market is done using leverage, meaning that the amount of currency that can be purchased or sold will be greater than the amount the investor puts at risk.
The cash that the investor keeps on deposit serves as ‘margin’, and covers potential losses of the trade in progress.
Choose the Trading Amount/Volume first
In the professional world, standard trade amounts of 5 to 20 million are in order.
Large trades of 100 million and more can be executed with large investment banks, which in turn will break up the trade into smaller units.
The trade amount, also known as the ‘face amount’ describes the number of units of the first named currency that will be traded:
Investor A sells 1 million EURUSD: he is selling 1 million Euros in exchange for US Dollars
Private speculators generally trade in smaller amounts.
Depending on their investment size and risk appetite, trade sizes vary between 10’000 and 10 million.
To facilitate trade amounts the expression ‘lot’ was created:
Definition of Forex Standard Lot
Standard of lot can be different for some brokers, but the following is used by majority of online FX brokers.
|1 lot for FX||100’000 for all currencies|
|1 lot for Gold||100 Ounces of GOLD|
|1 lot for Silver||1’000 Ounces of SILVER|
Investor A buys 4.5 lots USDJPY: he is buying 450’000 US Dollars in exchange for Japanese YEN
Which counter currency?
Remember that any trade is in fact an exchange of one currency against another at a certain price.
An investor buying a face amount of the first named currency is by definition selling the counter amount of the second named currency.
The counter amount is calculated by multiplying the face amount with the price at which a trade was done.
Open exposure of all trades
The moment a new trade is done, the investor is exposed to market movements.
The buyer will benefit from rising prices, the seller gains if prices fall.
Regardless of direction or face amount, the value of the counter currency will change as the price of the currency pair moves.
The net difference of the counter currency amount at the present market price compared to the trade entry price is called the ‘unrealized Profit or Loss’
Investor A sold 1.2 lots USDCHF at 1.2180.
Thus exchanging -120’000 USD against +146’160 CHF.
Market Offer 1.2155: +120’000 USD against -145’860 CHF: profit CHF 300
Market Offer 1.2195: +120’000 USD against -146’340 CHF: loss CHF 180
The profit or loss is called unrealized Profit/Loss.
The value of one pip:
We are now returning to the question of the value of 1 pip.
Using the last example we can express the unrealized profit or loss in pips.
Between the selling price of 1.2180 and the potential profit price of 1.2155 lie 25 pips.
Knowing the potential profit is CHF 300, 1 pip represents CHF 12.
This calculation is also true for the difference between 1.2180 and 1.2195 which is 15 pips or 180 CHF: 180/15=12 CHF per pip.
1 pip can be expressed as 0.0001 in the case of currency pairs quoted to the 4th decimal or 0.01 if the price quotation ends at the 2nd decimal such as USDJPY or XAUUSD.
Its value always occurs in the counter currency; in CHF for USDCHF or XAUCHF and in USD in the case of EURUSD.
3 lots XAUUSD: 300 * 0.01 = 3 USD
4.5 lots EURGBP: 450’000 * 0.0001 = 45 GBP
10.2 lots SARJPY: 1’020’000 * 0.01 = 10’200 JPY
Calculating Profit and Loss:
A successful speculator captures the price difference of a currency pair by buying when the price is low and selling the same currency pair when the price is high(er).
A completed trade is made up of a trade pair; it needs a ‘buy’ and a ‘sell’ of the same currency pair and of the same face amount to complete a trade.
The face amount and the price difference of the two trades will determine the net profit or loss of the completed or ‘closed’ trade
Trade 1: BOUGHT 4.2 lots USDCHF at 1.2465
Trade 2: SOLD 4.2 lots USDCHF at 1.2508
Price difference: 1.2508 – 1.2465 = 0.0043 (positive value = profit), amount 4.2 lots = 420’000
PROFIT: 420’000*0.0043 = 1’806 CHF
NOTE: Trade amount is USD 420’000 (first named currency)
NOTE 2: Profit or Loss is expressed in CHF (second named currency)
NOTE 3: The profit/loss is then converted into the speculators
Accounting currency, in the case of USD: CHF 1806 / 1.2508 = USD 1’443.88