How to calculate profit and loss in Forex trading

Knowing how to calculate profit and loss in Forex trading is a useful skill you should develop to protect your account and to react fast and neatly to any market movement. It is not just about to have a notion of how much will be your gross profit, but a sense of opportunity when things go in your favor but especially against you.

Forex trading is a hard enterprise but a profitable one for well-educated investors. Traders need to understand their potential profits and losses because it affects risk management and margin balance in their trading account.

Today, we will talk about the art of measuring profits and losses in the Foreign Exchange market. Besides, let’s check how you can take advantage of having specific portfolio targets and how to avoid paying high taxes from your investments.

Finally, we will get to understand the value of pips, because as traders, we don’t make money, but pips. Interesting, right? Keep reading, and we will discover a new level of interaction with money, value, and market synergies.

Traders make pips, not money

Let’s be clear here. We are not saying that we will take our earned pips as a different cryptocurrency and exchange it for goods or services. What we are exposing here is the fact that everybody in the Forex market has the same accountable tool: The pip.

But first, let’s talk about what a pip is. As the Forex Peace Army education support clearly says, “0.0001 is a most common minimum fraction of rate, and it is called a pip.” Pip is an acronym for ‘Percentage in Point,’ and is the smallest price move that a currency pair can make. A pip equals one-hundredth of one percent or the fourth decimal of the cross.

Therefore, when you make pips, you are winning money. At the same time, when you lose pips, you are losing money. Now, the value of your pip can vary depending on the size of your position.

Let’s say that you are trading a lot in the EUR/USD at 1.10426. One pip will equal €9.05584; In the same line, if you have a position of two lots, the value of your pip will be €18.1117.

However, if you trade mini-lots of 0.10 lots, every pip will have a value of 0.905584. With micro-lots of 0.01 lots, pip’s rate will be 0.090558.

Why is that so important? Because it will give you a sense of profitability measure in percentage and number of pips.

Let’s say that you are trading with a €1,000,000 account at a decent profitable rate of 1% monthly. That’s good. Now, what happens when you are investing with a €1,000 account at a 10% profitable rate? Even though you are making less money with the €1,000 portfolio, your performance is undoubtedly much better than the big one.

When calculating profits, or losses, what you should do is to multiply the amount in pips of base currency for lot size. Let’s say you have won 100 pips in a lot size position. So, 0.0100*100,000=1,000.

The same results with pips. Measure your trading by pips, and you will consider yourself an equal to others no matter if your portfolio is bigger or smaller than the others because you make pips, no money. The more pips you do, the more profitable you are.

What is profit

Profit is when the difference between the opening price is better than the closing price of your position. In a long trade, you will get gains when your purchase price is lower than your sale price. On the other hand, after going with a short position, you will have profits when your sell rate is higher than your buy price.

What are losses

A loss is when the difference between the opening and closing prices go against your interests. In a long trade, you will get losses when your purchase price is higher than your selling rate. In a short position, a loss will appear if your selling price is lower than your purchase price.

Unrealized and realized profit and loss

As Forex trading is a never sleeping machine that works from Monday morning in Australia until Friday afternoon in California, all Forex trades will be shown market to market in real-time.

As positions are calculated in real-time, you can see how they are performing in real-time. So, your platform measures prices and position performance, and it shows the current result of your position at that moment. It is called unrealized profit and loss because at the moment you decide to close your trade at current market to market value, it will become realized profit and loss.

At that moment, if you have profits, your portfolio value will be increased, while it will be decreased if you get a loss. That being said, you should also pay attention to total margin balance, which is the sum of the initial margin deposit, unrealized profits and losses, and realized P&L.

Remember that the total margin balance will keep changing when you have opened positions as its market to market value will keep fluctuating.

Calculating profit and loss in forex trading

As Forex prices move quickly, it is crucial to know how to calculate potential profits and losses, especially in volatile times, so you can adapt yourself, protect your portfolio, and react fast to violent market price movements.

The process is not complicated and the only thing you need to pay attention to and follow is the formula. The numbers that you will need are the position size and the number of pips that the pair has moved. Actual profit or loss will be the result of the position size multiplied by the number of pips moved.

First, let’s make clear what position sizes are, as Commander in Pips and Pipruit point out in the Forex Peace Army academy:

• Standard lot = 100 000 units of Base currency
• Mini Lot = 0.1 of Standard Lot = 10 000 units of Base currency
• Micro Lot = 0.01 of Standard Lot = 1000 units of Base currency
• Other lower Lots, sometimes it calls as “Nano Lots” = 0.001 of Standard lot = 100 units of base currency
• Free lot size – some brokers allow choosing any lot size by the client at wish.

Now, let’s calculate profit with the EUR/USD:

The current rate for EUR/USD is 1.1000/1.1005 (where 1.1000 is the selling price, and 1.1005 is the buy price. The spread is 5).

Then, you open a short EUR position of 10,000 units at 1.1000. This mean you bought 11,000.00 USD ((10,000 EUR * 1.1000 = 11,000.00 USD).

After opening the position, the market rate of EUR/USD goes down to 1.0950/1.0955. You decide to buy back 10,000 EUR at 1.0955 (10,000 EUR * 1.0955 = 10,955.00 USD).

You sold 10,000 EUR for 11,000 USD and bought back 10,000 EUR for 10,955 USD. Finally, Your profit is 45.00 USD (11,000.00 – 10,955.00).

Now, let’s calculate losses with the GBP/USD

The current rate for GBP/USD is 1.3000/1.3005 (where 1.3000.00 is the selling price, and 1.3005 is the buy price. The spread is 5). You open a buy position of 10,000 GBP at 1.3005.

This means you purchased 10,000 GBP and sold 13,005 GBP (10,000 USD * 1.3005 = 13,005).

Suddenly, the market rate of GBP/USD falls to 1.2945/1.2950 and you decide to sell back 10,000 USD at 1.2945 (10,000 USD * 1.2945 = 12,945 GBP).

After closing the position, you bought 10,000 USD for 13,005 GBP and sold 10,000 USD back for 12,945 JPY.

Your loss will be 13,005 – 12,945 = 60 GBP. Note that your loss is in GBP, to calculate back to USD, 60 / 1.2945 = 77.67 USD.

Taking taxes as a part of your trading profit

As you may know it, governments use investing, gains and loss taxation rules. Every country has different rules and regulations, but overall, most separate occasional traders from day traders and short-term from long-term profits and losses.

In the United States, you should pay taxes every year. The IRS collects the money, the FINRA determines the rules whether you are considered as a short or long term beneficiary of investing gains, and the NFA and CFTC regulate the brokerage and customer markets for the Forex Industry.

In that framework, a day trader is a person who opens and closes four or more trades within five days. Also, if those operations are more than 6% of your total trading activity, and all positions are often settled before the end of the session, you are a day trader.

In terms of specific taxation, Forex futures and options are overall taxed using the 60/40 rule, when 60% of gains or losses are treated as long-term capital gains, but the other 40% as short-term.

On the other hand, the Commodity Futures Trading Commission (CFTC) and the National Futures Association (NFA) are responsible for regulating the forex market in the US. All forex brokers that want to operate in the United States must be registered with the NFA.

In terms of ability to trade and invest, the NFA has the compliance Rule 2-43b which states that retail foreign exchange dealers can not allow clients to hedge and must close positions on FiFo, or first-in-first-out basis.

Hedging is allowed in other countries but forbidden in the United States. Also, the NFA Compliance Rule 2-43b doesn’t allow price adjustments to execute customer orders, except if it is in favor of the customer and following a complaint.

Long story, in short, day traders pay more taxes than long-term investors as gains are subject to more “occasional” features. The regulator considers short term as if you win the lotto, instead of long term, when you spend several hours working on your profit.

In any case, please check the taxation rules in your country and pay what you owe. Don’t try to cheat or beat the system.