More on calculations used in FOREX is provided on money management. You’ll eventually need to be able to make these calculations instantaneously; the FOREX markets move quickly, real-time, and you’ll need to concentrate on trading, not calculations.
But don’t worry if they don’t come to you right away. Most broker trading platforms have FOREX calculators you can use to become familiar with how the various values and units interact. Remember that a currency transaction is between two currencies, not a single currency and a product is true as in stocks and commodity futures.
You may either buy or sell a currency, profiting if it goes up or down. If you buy a currency, you are said to be long and an offsetting transaction is to sell. If you sell a currency, you are said to be short and an offsetting transaction is to buy.
EUR/USD is the symbol for the euro-to-U.S. dollar currency pair. If you buy, you are going long the front or base currency and effectively short the back or counter currency. If you sell, you are going short the base currency and effectively long the counter currency.
The basic calculations you will want to learn are the following:
Leverage and Margin Percent
Leverage = 100 ÷ Margin Percent
Margin Percent = 100 ÷ Leverage
Leverage: is typically quoted as a ratio of X:1, where 1 is the margin for the position and X is the value of the position. For example, 100:1 means you control 100 times the margin amount. Typically anything under 50:1 is considered low leverage, whereas over 100:1 is very high. New traders should begin with low leverage (e.g., 10:1) and increase by 10:1 units as their confidence increases and until they maximize their money management parameters. Read Also: How To Be Successful In The Forex Market – Preserve Your Capital
Pips: A pip is typically the smallest increment that any currency pair can move in either direction, up or down. In FOREX, profits and losses are calculated in terms of pips first, dollars second. The pip is very much the basic FOREX value. Some brokers now offer fractional pips on the more popular pairs.
The pip is typically $10 on a 100,000 currency lot, $1 on a 10,000 lot, and $25 on a 250,000 “bank” lot.
Profit and Loss: Very basically, profit or loss is price change, which in turn is exit price minus entry price. If the value is positive, you made a profit; if it is negative, you lost.
Profit in Pips = Price Change × Pips
Profit in USD = Price Change × Units Traded
Trading Units: You will always want to know how many units of a pair you can buy or sell. Again, almost all broker-dealer trading platforms offer this information—but you should know how to calculate it on your own, also.
Units Available = 100 × Margin Available × Rate ÷ Current Price × Margin Percent
If the USD is the base currency:
Units Available = 100 × Margin Available ÷ Margin Percent
Standard trading units are 10,000, 100,000, and 1,000,000.
Margin
Margin Requirement = Current Price × Units Traded × Margin Percent ÷ 100
Most retail broker-dealers now limit how much of your total account value may be committed to active trades.
Transaction Cost
In FOREX, cost is a function of the bid/ask spread.
Spread = Ask Price − Bid Price
Transaction Cost = Spread × Units Traded
Typical pip spreads run between one and three pips for active markets such as the EUR/USD and four to five pips for less active markets. You pay the pip spread both when you enter (buy/sell) and when you exit (sell/buy). Read Also: How To Increase Your Saving With A Budget
Pip spreads may vary widely in fast markets, slow markets, and before and after a news announcement. Market makers use this in principle at least to maintain an orderly market.
All broker-dealer platforms automatically calculate these figures. Nevertheless, the complete FOREX trader will want to be able to do them on his or her own. At the minimum it will add confidence to your knowledge of the business and provide a check against any calculations made on your broker’s platform.
A few hours with a demo trading account will be an invaluable tool in becoming familiar with the basic FOREX calculations. A picture or an example is worth a thousand words. We suggest you work with only the most popular pair initially, the EUR/USD. After you have mastered the calculations therein, proceed to the other popular pairs and crosses.
USD/CHF
USD/JPY
GBP/USD
EUR/JPY
EUR/CHF
EUR/GBP
GBP/JPY
GBP/CHF
AUD/USD
Orders: The palette of FOREX orders to enter a market, protect a trade, and exit a market is large and varied. Some broker-dealers support their own unique order types, as well. The new trader can manage everything comfortably with three basic order types: market, limit, and stop orders.
Market Orders: A market order is an order to buy or sell at the market price. The buy may be to initiate a new position or liquidate a previous sell position. The sell may be to initiate a new position or liquidate a previous buy position. A market order may not be filled at the current price, though, since, like a river, prices are always flowing. Most market makers show you the price you will receive before you execute the order.
In requoting, you do not get that price. Large orders and slow, fast, and illiquid (thin) markets affect the price you will receive on a market order.
A buy adds to aggregate demand and pushes prices up, if only slightly; a sell adds to aggregate supply and has the opposite effect. The bid/ask spread in FOREX reflects this, as well as protecting your broker and helping him maintain an orderly book—and make a fair profit by serving you.
Limit Orders: A limit order specifies a certain price to execute your order. It may also specify duration how long you wish to keep the order active. A limit order is filled at your price or better.
Stop-Limit Orders: There is also a stop-limit order. You specify a price and also a maximum range beyond that price for which the order can be executed. The advantage of a stop-limit order is that you will get the price you want if that price is reached. The disadvantage is that if prices do not trade in your specified range, your order remains unexecuted. In a fast market, a stop-limit order may be a complete waste of effort; they simply will not be executed. Read Also: How To Increase Your Twitter Followers – Five Proven Ways
A suggested rule of thumb: Use market orders in normal markets, and use limit orders for large orders and in fast, slow, and thin markets.
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