How the profit and losses are calculated is one big mystery for Forex trading beginners. In the following article we will try to demystify the topic by clarifying some of the unique and specific Forex terms that are used to calculate profits and losses on Forex transactions.
Forex deals are completed using lots of currency. One standard lot is 100,000 units. The units refer to the base currency in the transaction. For example, in a transaction involving USD/GBP, US dollars are the base currency. Hence 1 lot of USD/GBP would represent 100,000 dollars. On the other hand if the amount is one lot of EUR/USD, the amount involved is 100,000 Euros. Lots may come in different sizes such as micro, mini or standard.
Rule of thumb for lots: the smaller the lot, the lower the profit or loss amount
Pip Values and Pip Spreads
This refers to the smallest unit price that can be traded. Pips are indicated up to 4 decimal points. But the fact that a lot is a unit of 100,000 makes the pips refer to not-so-small amounts. Pip spreads are very important when calculating profits on a transaction. This is because any Forex transaction always involves two steps - buying one currency and then selling another.
So if the investor has just made a loss, he would need to buy a currency at a price that is up by one pip to make even the loss. Any prices over and above the spread would be profit.
Rule of thumb for pips: the smaller the pip spread, the easier it is to make a profit
Investors can borrow money from a Forex trader to open up positions in the market. Online brokers allow a leverage rate of 90% without charging interest.
Rule of thumb for leverage: high leverage ratios increase the chance of big profit as well as maximize the chances of a loss