Calculating Profit/Loss in Forex Trading

Trading currencies involves more than technical knowledge and up to date information regarding market news and events. Each trade has its own numeric particularities, which will determine your profit/loss depending on several factors, such as: lot size, pip value, spread and leverage. This article will explain in 3 examples how you can manage your buy/sell orders in order to successfully achieve the expected results for each one of them.

In our first example, we are going to buy the EUR/CHF pair (euro vs. Swiss franc). Buying this pair means that we are expecting the euro to gain value against the Swiss currency. Considering this order to be worth 10,000 EUR we can use a simple calculation to determine the amount of euros in one pip of profit or loss. Here are the numbers:

The EUR/CHF long (buying) price is at 1.5187 and 0.0001 is one pip. To determine the value of one pip from 10,000 EUR we have to do the following:

(Pip value/pair price) x order sum, and in this case it would be:

(0.0001/1.5187) x 10000 = 0.65 euro cents

It is very important to stress on the pip value, since pairs values can be tricky enough to the point any distraction may lead the trader to make mistakes, the same amount of money when trading different pairs can affect drastically the pip value, and by consequence, your profit/loss ratio.

Let’s consider you could have closed your market order at 1.5205. How can we calculate our profit?

Taking into account that we had a 2 pips spread when opening our order, and from 1.5187 to 1.5205 we have a profit of 18 pips minus 2 pips from our initial spread value. Our pip value as mentioned above is 0.65 euro cents, giving us a final sum of 0.65 × 18 = 11.70 euros.

The second example will stress on the effectiveness of scalping within a low-spread market. The pip spread value may vary from one broker to another, and generally, different moments and events affect the spread size directly. Normally the pair with the lowest spread size is the EUR/USD, and considering that scalps normally have small pip-profits, using a high leverage is the key to have substantial profits while scalping.

Let’s imagine the following values for the EUR/USD 1.3145, with a one pip spread size. If you have 1.000 USD and a leverage of 1:100, you can trade lots worth up to 100,000 USD, which in this case would mean a 30 USD profit for a 3 pips positive closed market order.

Our final example will approach a strategy for avoiding losses while trading Forex. The same value for the EUR/USD from the example 2 can be used for this example, selling the EUR/USD at 1.3145, and remembering that your target price would be probably be achieved after a period in which you may not be able to verify the order constantly, it is wise to set a stop/loss value for the next support/resistance point, which in this example, would be 1.3100. The lot size is equivalent to 10,000 USD, giving a pip value of 1.00. Market events and political decisions may have a strong influence on the Forex market, so imagining that a favorable decision for the USD made the pair go to 1.3055, your stop/loss helped you to avoid losing more 45 dollars, giving you a much less significant loss than if you would not have set a stop/loss price for the order.

by http://www.forexnewbies.com

Drawdown and Risk/Reward Ratio: The Danger of a Losing Streak

Drawdown and risk/reward ratio are two parameters to always keep in mind when trading forex, as they indicate your risk factor for your open trades in a very precise and clear way.

Even if you feel very confident about your trading strategy, using one that results in a gain, say, 65% of the time, Murphy’s Law (which is not just a cute joke, as it can be mathematically proved) says that sooner or later you’ll incur in a losing streak. It’s important to keep these chances to a minimum by using a proper risk/reward ratio and, when a losing streak happens, to keep drawdown in serious consideration before you place your next trade.

Drawdown and Maximum Drawdown in Forex

Let’s say you lose a series of trades which bring your equity from an initial $10,000 to just $6,666.66. You lost 33 % of your account, but how much do you have to get back to where you started from, relative to your current account?

If you answered 33 %, you are wrong. The actual percentage you have to earn back is 50 %: in fact, $6,666.66 x 150% = $10,000, while $6,666.66 x 133 % = $8866.66. In other terms, you faced a 50-33 = 17% drawdown.

Let’s see what happens if you continuously lose 20 % and win 20 % of your account.

Trade 1	$10,000
Trade 2	$8,000
Trade 3	$9,600
Trade 4	$7,680
Trade 5	$9,216
Trade 6	$7,372.8
Trade 7	$8,847.36
Trade 8	$7,077.88
Trade 9	$8,493.46
Trade 10	$6,794.77

Do you see where it’s going? Due to drawdown, alternately winning and losing 20% (or any other percentage) of your account is not enough at the end of the day. This holds true even if you started with a winning trade — it would just take a bit longer.

As we hope you realized, recovering from a consistent loss, in forex like in any other form of investment, gets increasingly harder. This is why you need to try avoiding serious drawdown by using an adequate risk/reward ratio.

Risk/Reward Ratio in Forex

A risk/reward ratio is, like the term suggests, the ratio between the expected maximum loss and the maximum gain. The great thing about forex trading is that you can decide your r/r with absolute precision by placing appropriate stop losses and take profits.

For instance, if you place your stop loss at 20 PIPs and your take profit at 40 PIPs, your r/r is 1/2. Please note that some say “reward/risk” ratio, so in this case the r/r would be 2: always make sure of what others mean, unless it’s obvious from the context.

What is a good r/r ratio? If you understood what we just said about drawdown, you know that a ratio of 1 is not going to work in the long term! In fact, drawdown is precisely the reason why you should always enter trades with a stop loss tighter than your take profit.

As an example, if you use a risk/reward ratio of 1/2 and your strategy lets you win 50% of your trades, here is what your account will look like after alternately winning 20% and losing 10% of your account:

Trade 1	$10,000
Trade 2	$9,000
Trade 3	$10,800
Trade 4	$9,720
Trade 5	$11,664
Trade 6	$10,497.6
Trade 7	$12,597.12
Trade 8	$11,337.41
Trade 9	$13,604.89
Trade 10	$12,244.40

Of course, entering in trades at random won’t give you a 50% chance of winning, because the profit target is more distant than the stop loss (and don’t forget you have to factor in the spread, too): however, with the help of tools from technical analysis and a bit of experience, coming up with a strategy to earn this figure is certainly feasible.

by http://www.forexnewbies.com/

Forex Problems You Will Face

At some point of their learning curve newbie traders eventually face some of the problems that are intrinsic to the Forex trading industry. So, what are these problems, how to deal with them or even avoid them?

Old Strategies Stop Working. You should be ready to update, tweak and tune your Forex trading strategy if you want to keep it profitable. Market conditions evolve and the old strategies become less effective. Of course, some of the simple strategies are made for all kinds of market states but even they’ve got a lot of parameters to optimize for the specific conditions.

Real Account Experience Different From Demo. Although demo account trading is almost the same as the real account trading there are caveats. First, demo trading involves almost no emotions as you don’t risk live money. Second, demo trading execution is usually very smooth on all Forex brokers while the real one can be quite bad, especially during the times of the elevated market volatility (during the news releases or the overnight interest rate application).

Scam Brokers. Unfortunately, not all Forex brokers are honest, there are scam ones among them. Scam brokers offer all sorts of problems to their clients: from aggressive slippage and artificial market spikes to blatant stealing of the deposit/profit funds. Avoid unknown Forex brokers and stick with the reputable ones.

Too Little Knowledge. Jumping into trading with too little theoretical and practical knowledge is a good way to lose money. Experience comes from trading and learning. Practice on demo a lot, learn new things about Forex; if something doesn’t work as you expect it to try to find out why it doesn’t.

Overtrading. Be moderate in trading. Don’t open your next position just because you’ve just closed one in profit. And don’t open a new position to cover the losses of the previous positions. Simply put: don’t trade when your mind or emotions tell you to trade but trade when the market tells you so.

Paid Forex Strategies/Robots. They cost a lot, they don’t work as the advertisements promise you and they won’t make you rich. Even more so, there are a lot of free strategies, robots and expert advisors available in the Internet.

Search for Forex Holy Grail. Simple don’t. It’s just a waste of time. The effective financial markets (which Forex definitely is) don’t allow the existence of such things.

Be careful, prudent and serious in you approach to the Forex market and you’ll reap your reward.

by http://www.forexnewbies.com/