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Calculating Profit and Loss in Leveraged Trading

Pip 

Sometimes also referred to as a 'tick' the term is used in currency markets to represent the smallest incremental move an exchange rate can make. Because the majority of exchange rates are quoted to the fourth decimal place, (ie EUR 1.3744 NZD 0.7885) then a one 'pip' move would be 0.0001 to 1.3745 and 0.7886 respectively. The value of a 'pip' is not always the same and can differ per currency.  

Here are some examples based on a currency amount of 100,000 units of the BASE currency;  

EUR/USD = 10.00 USD
USD/JPY = 100 YEN
NZD/USD = 10.00 USD
USD/CAD = 10.00CAD
AUD/USD = 10.00 USD
NZD/JPY = 100 YEN 
EUR/GBP = 10.00 GBP

 

Leverage 

The most enticing aspect of trading Forex in the last 5 years is the high degree of leverage used.

Leverage is the degree to which a client or investor can use borrowed money. To enable them to do this they place an amount of money on deposit with a firm (margin) and effectively borrow against this money. Leverage of 50/1 or 100/1 is common.

However, it comes with greater risk. If an investor uses leverage to make a currency trade and the position moves against the investor, his or her loss is much greater than it would've been if the investment had not been leveraged - leverage magnifies both gains and losses.

Leverage seems very attractive to those who are expecting to turn small amounts of money into large amounts in a short period of time. However, leverage can be a double-edged sword. It can magnify the losses as well as the gains. Most traders analyse the charts correctly and place sensible trades, yet they tend to over leverage themselves (get in with a position that is too big for their portfolio). As a consequence they often end up forced to exit a position at the wrong time because they cannot meet a margin call or their positions have been closed out for them.

However, properly managed, leverage is a powerful tool and has been used successfully in equity markets over many years.

Margin Explanations 

Margin Account

Is an account in which a company or brokerage firm involved lends the client (trader) cash with which to trade financial products. Unlike a normal cash account a margin account allows the client to trade these products with  money that effectively he/she does not have.

Initial Margin

The initial or original amount required by the firm to be placed on deposit before the client can begin ‘trading'. This is normally a set standard amount.ie $10,000 of the base currency they wish to trade in.

Variation Margin

Is the additional margin required to bring the clients account up to the required level due to fluctuations within the market. Also known as a ‘top-up'

Margin Call

A call from the company to a client (trader) demanding the depositing of further monies to satisfy an in-house requirement and provide cover for an adverse price movement  With a trading platform clients are advised in advance that their initial margin is becoming too low to cover their existing positions and warned that a ‘top-up' is required.

Close Out

Is the liquidating of a traders position or positions because that account holder failed to meet a variation margin or margin call.

Please note

As per the client agreement the client will automatically be closed out if their positions fall below the 2% threshold.

Profiting from trades  

You buy a currency if you expect the first-named currency to strengthen against the second second-named currency, and you sell a currency if you expect the first-named weaken against the second-name currency.

Example of making money by buying NZD's:

 Trader's Action

 NZD

 USD

You Purchase 10,000 NZDs at
the NZD/USD exchange
rate of 0.7500

+10,000

  -7,500

One week later, you exchange your 10,000 NZDs back into
US dollars at the exchange
rate of 0.7600

-10,000

 +7,600

You earned a profit of
$100USD @0.7600=NZD131

 0

 +100

 

Example of making money by selling NZD's:

 Trader's Action

 NZD

 USD

You Sell 10,000 NZDs at
the NZD/USD exchange
rate of 0.7500

-10,000

 +7,500

One week later, you exchange your 10,000 NZDs back into USD at the exchange rate of 0.7400

+10,000

  -7,400

You earned a profit of $100USD
@0.7400= NZD135

 0

 +100

 

Follow these links to learn more about FX Trading.

FOREX BASICS

 

TRADING STRATEGIES

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Source: LatitudeFX Limited

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