1. A Currency Pair and Quotation
2. Main Currency and Pair abbreviations
3. The Profit Mechanics
4. Pip Value (Price) Calculation
5. A Trading Operation
6. Spread
7. Bid (Sell) & Ask (Buy) Price when Buying or Selling
8. Profit/Loss Calculation
9. Margin Trading and Trading Volumes

A Currency Pair and Quotation

In the very name of Forex (Foreign Exchange) there is an answer to the question what it operates – currencies (exchange of one currency for another). Unlike the previous long gone system, value of currency is nowadays determined by numerous constantly changing factors such as economic performance, interest rate, political situation and many others – all related to the county of issue, not to mention the market's current demand. In Forex one currency's value is quoted in another's constituting a so called Currency Pair (Trading Instrument). For example:

Value of Euro is expressed in U.S. Dollars. If 1EUR costs 1.3610 USD, the Currency Pair's quotation will be 1.3610:

In this currency pair EUR is base currency and USD is quoted currency.

Back to the top

Main Currency and Pair abbreviations

Back to the top

The Profit Mechanics

Trading result (profit or loss) depends on how much a currency rate changes. In case of Forex, currency rate plays the part of price, base currency (always at the beginning) - is a product, and quoted currency - is a mean of payment. In Forex you can make profit in both cases - whether the rate is increasing of decreasing:

1. When the rate is increasing, you are buying the base currency for the quoted one, so that to sell it with a profit at a higher price (expressed in the quoted currency).
2. When the rate is decreasing, you are selling the base currency for the quoted one, so that to buy it with a profit at a lower price (expressed in the quoted currency).

Back to the top

Pip Value (Price) Calculation

Rate fluctuations are measured in Pips. It is essential to know the Value of a Pip (Pip Price) before planning your trades. Pip value depends on a trade (trading position) volume (size). Examples:

EUR/USD rate is 1.4936 (meaning that 1 Euro equals 1.4936 US Dollar). 1 pip minimum volume is 0.0001

If your Position Volume (Size) is 100.000 of base currency, then 1 Pip Value (Price) = 100.000 x 0.0001 = 10 USD

If your Position Volume (Size) is 10.000 of base currency, then 1 Pip Value (Price) = 10.000 x 0.0001 = 1 USD

If your Position Volume (Size) is 1.000 of base currency, then 1 Pip Value (Price) = 1.000 x 0.0001 = 0.1 USD

If your Position Volume (Size) is 100 of base currency, then 1 Pip Value (Price) = 100 x 0.0001 = 0.01 USD

USD/CHF rate is 1.0850  (meaning that 1 US Dollar equals 1.0850 Swiss Franc). 1 pip minimum volume is 0.0001

If your Position Volume (Size) is 100.000 of base currency, then 1 pip = 100.000 x 0.0001 = 10 CHF = 10/1.0850 = 9.2166 USD

If your Position Volume (Size) is 10.000 of base currency, then 1 pip = 10.000 x 0.0001 = 1 CHF = 1/1.0850 = 0.9217 USD

If your Position Volume (Size) is 1.000 of base currency, then 1 pip = 1.000 x 0.0001 = 0.1 CHF = 0.1/1.0850 = 0.0922 USD

If your Position Volume (Size) is 100 of base currency, then 1 pip = 100 x 0.0001 = 0.01 CHF = 0.01/1.0850 = 0.0092 USD

As you can see, a pip value (price) goes down as a position (trade) volume decreases and is nominated in a second currency in a pair (Quoted Currency).

Back to the top

A Trading Operation

A trading operation consists of two stages:

1. First, you open a trading position - purchase an amount of base currency for quoted one
2. Then, after the quotation (price) has changed, you close your trading position - sell the same amount of base currency for quoted one

As you can see, you need to first buy a poduct (base currency), wait until the price (quotation) changes and then sell the earlier bought product (base currency) with profit. Quoted currency is always a mean of payment.

NOTE: Given example relates to a long (Buy) trading position, nevertheless, you may as well open a short (Sell) trading position by selling a base currency with an intent to buy it back cheaper - if you recon the quotation is going to decrease.

Back to the top

Spread

There are always Bid (Sell) and Ask (Buy) prices on the market for every trading instrument. This is due to the spread. Traditionally only Bid price is represented on the chart.

Back to the top

Bid (Sell) & Ask (Buy) Rates when Buying or Selling

You always buy at an Ask price and sell at a Bid price:

Buy and Sell more expensive:

• opening a position (Buy at an opening Ask price)
• closing a position (Sell at the closing Bid price)

Sell and Buy cheaper:

• opening a position (Sell at an opening Bid price)
• closing a position (Buy at the closing Ask price)

BUY EUR/USD:

• first you open a BUY position: you buy EUR paying USD at an opening Ask rate
• then you close your BUY position by selling EUR and getting USD at the closing Bid rate

SELL EUR/USD:

• first you open a SELL position: you sell EUR getting USD at an opening Bid rate
• then you close your SELL position by buying EUR and paying USD at the closing Ask rate

Back to the top

Profit/Loss Calculation

A full trading circle is opening and closing of a position resulting in either profit or loss.

BUY 200.000 USD/JPY:

• We opened a BUY position: bought 200.000 USD at an Ask rate 95.650 paying 95.650 x 200.000 = 19.130.000 JPY 
• then we closed our BUY position by selling 200.000 USD at a Bid rate 96.400 getting 19.280.000 JPY
  

A differential between the initial Ask and the last Bid prices is 75 pips.

There are two ways of calculating our profit:

• 19.280.000 - 19.130.000 = 150.000 JPY
• A pip value (price) is 200.000 x 0.01 = 2.000 JPY; 75 x 2.000 = 150.000 JPY

Our profit is 150.000 JPY (or 1555.5325 USD)

Back to the top

Margin Trading and Trading Volumes

Forex Trading is Margin Trading. Thanx to a leverage offered by a broker, you only need your margin to cover positions you open.

If you have 1.000USD in your account and your maximum available leverage is 1:100, you are able to trade 100 times the volume of your balance which is 100.000USD.

Back to the top