Although most trading platforms calculate profits and losses, used margin and useable margin, and account totals, it helps to understand how these things are calculated so that you can plan transactions and can determine what your potential profit or loss could be.
Most forex brokers allow a very high leverage ratio, or, to put it differently, have very low margin requirements.
This is why profits and losses can be so great in forex trading even though the actual prices of the currencies themselves do not change all that much—certainly not like stocks. Stocks can double or triple in price, or fall to zero; currency never does.
Because currency prices do not vary substantially, much lower margin requirements is less risky than it would be for stocks. Before , most brokers allowed substantial leverage ratios, sometimes up to Such leverage ratios are still sometimes advertised by offshore brokers.
However, in , US regulations limited the ratio to Since then, the allowed ratio for US customers has been reduced even further, to The purpose of restricting the leverage ratio is to limit the risk. The margin in a forex account is often referred to as a performance bond , because it is not borrowed money but only the amount of equity needed to ensure that you can cover your losses. In most forex transactions, nothing is actually being bought or sold, only the agreements to buy or sell are exchanged, so borrowing is unnecessary.
Thus, no interest is charged for using leverage. Thus, buying or selling currency is like buying or selling futures rather than stocks. The margin requirement can be met not only with money, but also with profitable open positions. The equity in your account is the total amount of cash and the amount of unrealized profits in your open positions minus the losses in your open positions.
Your total equity determines how much margin you have left, and if you have open positions, total equity will vary continuously as market prices change. In most cases, however, the broker will simply close out your largest money-losing positions until the required margin has been restored.
The leverage ratio is based on the notional value of the contract, using the value of the base currency, which is usually the domestic currency. Often, only the leverage is quoted, since the denominator of the leverage ratio is always 1. The amount of leverage that the broker allows determines the amount of margin that you must maintain. Leverage is inversely proportional to margin, which can be summarized by the following 2 formulas:. To calculate the amount of margin used, multiply the size of the trade by the margin percentage.
Subtracting the margin used for all trades from the remaining equity in your account yields the amount of margin that you have left.
You want to buy , Euros EUR with a current price of 1. How many more Euros could you buy? In most cases, a pip is equal to. Because the quote currency of a currency pair is the quoted price hence, the name , the value of the pip is in the quote currency. If the conversion rate for Euros to dollars is 1. To calculate your profits and losses in pips to your native currency, you must convert the pip value to your native currency.
When you close a trade, the profit or loss is initially expressed in the pip value of the quote currency. To determine the total profit or loss, you must multiply the pip difference between the open price and closing price by the number of units of currency traded. This yields the total pip difference between the opening and closing transaction.
If the pip value is in your native currency, then no further calculations are needed to find your profit or loss, but if the pip value is not in your native currency, then it must be converted.
There are several ways to convert your profit or loss from the quote currency to your native currency. If you have a currency quote where your native currency is the base currency, then you divide the pip value by the exchange rate; if the other currency is the base currency, then you multiply the pip value by the exchange rate.
Subsequently, you sell your Canadian dollars when the conversion rate reaches 1. For a cross currency pair not involving USD, the pip value must be converted by the rate that was applicable at the time of the closing transaction. If the margin is 0.More...