How a FX trade works

The concept of trading FX is simple, once it is realized that a currency is a commodity whose value fluctuates against another currency. By buying (or selling) a currency, FX Traders look to earn a profit from the movement in the FX rate. The beauty of FX is that the cost of trading is so low. This means that trades can be transacted for the extreme short-term, literally seconds, as well as for a longer duration.

Example:

A trader believes the EUR is about to increase in value against the USD and buys €1 million at 1.5000. Shortly after, the rate is 1.5050 and the trader closes the position for a US $5,000.

€1,000,000 at 1.50 = US $1,500,000

€1,000,000 at 1.5050 = US $1,505,000

Difference = Profit of US $5,000

Majors

There are around 170 currencies in the world. However, activity is concentrated into six ‘major’ currency pairs, which account for around two-thirds of the total turnover.

The Majors are:

  • EURUSD (27%)
  • USDJPY (13%)
  • GBPUSD (12%)
  • AUDUSD (6%)
  • USDCHF (5%)
  • USDCAD (4%)

Currency Pairings

In FX, one currency is always quoted against another. The ‘base’ currency is the one that can be thought of as the reference. For instance, in a EUR/USD quote, EUR is the base currency and the quote defines how many USD it costs to buy. Similarly, in USD/JPY, USD is the base currency and the rate defines how many JPY it costs to buy.

Bid and Offer (Asks)

The Bid is the price the market is willing to pay for a certain FX currency pair. The offer, or ask, is the price it is prepared to sell at.

For example, in a USD/CHF quote of 1.1650/1.653, the bid is 1.1650, while the offer is 1.1653. Frequently, quotes are abbreviated to just the ‘small numbers’. In this case, a phone quote would be 50/53.

The difference between the bid and the offer is known as the spread.

Pips

A “Pip” (price interest point) represents the smallest fluctuation in price of a currency pair. For most currencies, the rate is quoted to the fourth decimal place, with USD/JPY the notable exception. A pip represents 1/10,000th or 0.0001 of the counter currency. A change of 1 pip for GPB/USD at 1.6319 is 1.6320. The Pip for USD/JPY is only quoted to the second decimal point (1/100th or 0.01).

Profit and Loss Calculations Examples

Examples:

Sold 3 lots of EURUSD at 1.2175 and bought them at 1.2110:

In this example, the client made 65 pips * 3 lots = 195 pips in total profit (as he sold at a higher price than he bought). The pip value for EURUSD is US $ 10, so the total profit =195 pips * US $ 10 per pip = US $ 1,950.

Bought 2 lots of USDJPY at 105.60 and sold them at 105.20:

In this example, the client made 40 pips * 2 lots = 80 pips in total loss (as he sold at a lower price than he bought). The pip value for USDJPY is 1000 JPY and this equals 1000 / 105.20 (price of USDJPY when the position was closed) = US $ 9.506 approximately, and so the client total loss = 80 pips * US $ 9.506 per pip = US $ 760.46.

Sold 2 lots of EURGBP at 0.7015 and bought them at 0.6940:

In this example, the client made 75 pips * 2 LOTS = 150 pips in total profit. The pip value for EURGBP is 10 GBP and this equals 10 * 1.8500 (assuming the price of GBPUSD was 1.8500 when the position was closed) = US $ 18.50, and so the total profit is 150 pips * US $ 18.50 per pip = US $ 2775.