Tuesday, November 3, 2009

4.4 Forex Calculus : Calculating Units Available

Before initiating a new trade, it is always advantageous to know
 the maximum number of units that you can safely trade without
risking a margin call based upon your current account balance.
Most trading platforms provide an online utility that calculates
this information.
Enter the following data fields to calculate the maximum number of units
to buy or sell:
Margin available. This is the amount in your margin account you
want to earmark for the current trade.

Margin percent. This is your broker’s margin percentage for leveraging
Currency pair. Select the corresponding currency pair. In this example,
select EUR/USD.
Current price. Enter the current ask price in the currency pair.
Conversion rate. If the quote currency in the selected currency pair is
USD, then enter “1.”

The formula to calculate the maximum units that can be traded is:
Units Available 
=100 x Margin Available x Rate / (Current Price x Margin Percent)

If USD is the base currency, then this reduces to:
Units Available = 100 x Margin Available / Margin Percent
Cross rates can be handled in the same fashion by simply manipulating
the conversion rate.
Note: Always decrease the units available slightly to avoid a
margin call. Recommended 10 percent.

4.3.7 Forex Calculus : Calculating Profit and Loss - Scenario 6

Non-USD Cross Rates (Base/USD) In the previous example,
the USD was the base currency in the conversion pair (USD/JPY).
Now USD is the quote currency of the conversion pair (GBP/USD).
So, in this case we want to buy 20000 units of EUR/GBP.
The entry price is 0.6754 and the exit price is 0.6772.
So, the price change is 0.0018.
The Conversion Rate now is the current price of the
GBP/USD pair. The reversal of the role of the U.S. Dollar in
the conversion pair (GBP/USD) requires another change
 in the profit formula:
Profit in USD = Price Change x Units Traded x Rate
$19.05 = 0.0018 x 20000 x 1.8902

Remember that when USD is the quote currency of the
conversion pair, you must multiply the rate. If USD is the base
currency of the conversion pair, then divide the rate.
You may have noticed there was no mention of transaction 
costs in the  six scenarios given. The broker always subtracts 
the transaction cost at the moment the trade is initiated; 
therefore transaction costs do not affect the above calculations.

Monday, November 2, 2009

4.3.6 Forex Calculus : Calculating Profit and Loss - Scenario 5

Non-USD Cross Rates (USD/Quote) 
Most experienced traders can mentally perform the arithmetic
 in these examples. It just takes practice. However, we
must now tackle cross rates, currency pairs where neither
 currency is the U.S.Dollar. Obviously the profit in pips 
will be initially expressed in terms of the quote (second) 
currency of the cross rate pair. The solution is simple:
Look up the current price of the currency pair containing
 USD and the quote currency of the cross rate pair.
Let's suppose we bought 10000 units of CHF/JFY.
Entry price is 85.46. Exit price 86.86. So, the price
change is 0.40.

The Conversion Rate of 105.32 is actually the cur-
rent price of the USD/JPY pair.
The adjusted profit formula  for this cross rate trade is:
Profit in USD = Price Change x Units Traded / Conversion Rate
$37.98 = 0.40 x 10000 / 105.32

4.3.4 Forex Calculus : Calculating Profit and Loss - Scenario 4

USD Is the Base Currency (Loss)
This example is arithmetically identical to the previous example,
except that a small loss was incurred. We purchased 5,000
units of the USD/CAD pair at 1.3152 and set a stop-loss limit

order at 1.3142, which, unfortunately, was triggered .
Using the same adjusted profit formula as in the previous example,
Profit in USD = Price Change x Units Traded / Exit Price
we find:
-$3.80 =-0.0010 x 5000 / 1.3142
Note: Always keep your losses small.

4.3.3 Forex Calculus : Calculating Profit and Loss - Scenario 3

USD Is the Base Currency (Profit)
If the quote (second) currency is not the U.S. Dollar,
then profit or loss must be converted to U.S. Dollars.
For example, a 35-pip profit in the USD/JPY pair means
that the 35 pips are expressed in Japanese Yen.
Therefore, one extra step is required to convert Yen to Dollars:
Conversion Rate.
If USD is the base currency of the currency pair
being calculated, then divide the profit or
loss by the exit price.
This simply converts the pip profit expressed as Yen 
to a profit expressed as Dollars.
 Thus, when calculating currency pairs where the base
(first) currency is the U.S. dollar, the profit formula must
be adjusted as follows:
Profit in USD = Price Change x Units Traded / Exit Price
or, specifically:
$33.09 = 0.35 x 10000 / 105.77
Obviously, all U.S. brokers perform this simple conversion
to U.S. Dollars before adding profits to your margin account.

4.3.2 Forex Calculus : Calculating Profit and Loss - Scenario 2

USD Is the Quote Currency (Loss) 
 This time with the GBP/USD currency pair.
In this instance, we initiated a 30,000-unit short (sell) trade in the
GBP/USD pair at 1.8863 and, sadly, it advanced against our hopes.
We exited at 1.8883, losing 20 pips. Since the quote currency 
(the second currency) is USD, we know the conversion rate is 1. 
Thus using the profit formula
Profit in USD = Price Change x Units Traded
we find that our profit is actually a loss:
-$60.00 =-0.0020 x 30000
If the above calculations are still causing some confusion,
 then reread, “The FOREX Lexicon.” As promised
before, these calculations only require 
the four simple arithmetic functions: 
addition, subtraction, multiplication, and division. 
No exponents, logs, or trig functions.
But this information must be completely clear before proceeding.
Keep in mind that it is your money at stake.

4.3.1 Forex Calculus : Calculating Profit and Loss - Scenario 1

USD Is the Quote Currency (Profit)
Currency pair.           The default is the EUR/USD pair.
Position.                     Choose either “buy” or “sell.”
                                   The default is “buy.”
Number of units.       This is the individual number of units
                                   and not the number of lots or mini-lots.
                                   A full lot should be entered as “100000”
                                   and a mini-lot as “10000.”
Entry price.               This is the entry price regardless if 
                                   the trade was a market order or
                                   a limit order.
Include the decimal point.
Exit price.                  This is the liquidation price regardless 
                                   if the trade was manually exited or a
                                   limit order was triggered.
Conversion rate.       This entry is necessary to convert any
                                   profit or loss to U.S.Dollars
                                   if the quote currency  is not USD.
                                  (the second one in the pair)
                                   In this example, USD is the quote currency.

 In this example we bought a mini-lot (10,000 units) of the
EUR/USD pair at 1.2563 and sold at 1.2588, netting a clear
profit of 25 pips (price change times pip factor,
or 0.0025 x 10,000). The price change is simply:
Price Change = Exit Price - Entry Price
The pip factor is the number of pips in the monetary unit of quote
currency. There are 10,000 pips in one U.S. Dollar and,
conversely, a single pip equals $0.0001.
The pip factor is therefore 10,000.
Profit in Pips = Price Change x Pip Factor
When the quote currency is the USD, profit or loss is calculated very
simply as:
Profit in USD = Price Change x Units Traded
.In our scenario, this equates to:
  $25.00 = 0.0025 x 10,000

4.3 Forex Calculus : Calculating Profit and Loss

Many FOREX trading platforms offer their clients a variety
of online utilities that assist the investor in his or her trading
Because all profits are expressed in U.S. dollars, a key factor
in the calculation of profit and loss is the currency pair and 
whether the USD is the base currency or the quote currency,
or if the currency pair is a non-USD cross rate.
Remember that the first currency in a currency pair is called 
the base currency (determines the number of units traded)
and the second is called the quote currency 
(determines the pip values of each price change).
Throughout the global spot currency market the term current price
is normally defined as:

Current Price =(Ask Price + Bid Price)/2

TIP: Always make sure that what you mean by any term 
is the same as what your broker-dealer means by that term.
Definitions do vary, usually slightly.
But even a small difference can lead to an error.

4.2 Forex Calculus : Pip Values

A pip is the smallest price increment that any currency pair
can move in either direction. In the FOREX markets, profits
are calculated in terms of pips first, then dollars second.
                        USD = Quote Currency
                EUR/USD               .0001 USD
                GBP/USD               .0001 USD
               AUD/USD               .0001 USD
                        USD = Base Currency
               USD/JPY                .01 JPY
               USD/CHF               .0001 CHF
               USD/CAD              .0001 CAD
                       Non-USD Cross Rates
               EUR/JPY                .01 JPY
               EUR/CHF               .0001 CHF
               EUR/GBP               .0001 GBP
               GBP/JPY                .01 JPY
               GBP/CHF               .0001 CHF
               CHF/JPY                .01 JPY

Currencies           1 Pip Value Per Full Lot (100,000 units)
EUR/USD           EUR 100,000 x .0001= USD 10.00
GBP/USD           GBP 100,000 x .0001= USD 10.00
AUD/USD          AUD100,000 x .0001= USD 10.00
USD/JPY            USD 100,000 x .01 = JPY 1,000
                                   / USDJPY spot (105.50) = USD 9.47
USD/CHF          USD 100,000 x .0001= CHF 10.00 /
                          USDCHF spot (1.2335) = USD 8.11
USD/CAD         USD 100,000 x .0001= CAD 10.00 /
                          USDCAD spot (1.3148) = USD 7.61
EUR/JPY           EUR 100,000 x .01 = JPY 1,000 /
                          USDJPY spot (105.50) = USD 9.47
EUR/CHF          EUR 100,000 x .0001= CHF 10.00 /
                          USDCHF spot (1.2335) = USD 8.11
EUR/GBP          EUR 100,000 x .0001= CHF 10.00 x
                          GBPUSD spot (1.8890) = USD 5.2
GBP/JPY           GBP 100,000 x .01 = JPY 1,000 /
                          USDJPY spot (105.50) = USD 9.47
GBP/CHF          GBP 100,000 x .0001= CHF 10.00 /
                          USDCHF spot (1.2335) = USD 8.11
CHF/JPY           CHF 100,000 x .01 = JPY 1,000 /
                          USDJPY spot (105.50) = USD 9.47
 Approximate USD values for a one-pip move per contract
in the major currency pairs are shown above, per 100,000
units of the base currency.
On a typical day, actively traded currency pairs like EUR/USD
and USD/JPY can fluctuate 100 pips or more. 
The above table is based upon a margin requirement of 
100 percent (leverage = 1:1). To calculate actual profit (or
loss) in leveraged positions, multiply the pip value per 100k times
the leverage ratio (margin percentage divided by 100).
Note that the EUR/GBP cross rate pair above uses multiplication
with the USD spot price instead of division. 

This is because the USD is the quote (second) currency 
in the spot conversion pair.

4.1 Forex Calculus : Leverage and Margin Percent

Some brokers describe their gearing in terms of a leverage ratio
and others in terms of a margin percentage.
The simple relationships between the two terms are:
Leverage = 100 / Margin Percent
Margin Percent = 100 / Leverage

Leverage is conventionally displayed as a ratio, 
such as 20:1 or 50:1.
In the examples that follow which require leverage,
will be use only the number on the left side of the ratio—that is,
20 or 50—since the number on the right side is always 1.