Calculating Profit and Loss For ease of use, most online trading platforms automatically calculate the P&L

o f a traders' open positions. However, it is useful to understand how this calcul ation is formulated To illustrate an FX trade, consider the following two examples. Let's say that the current bidask for EURUSD is 1.461619, meaning you can buy 1 euro for 1.4619 or sell 1 euro for 1.4616. Suppose you decide that the Euro is undervalued against the US dollar. To execut e this strategy, you would buy Euros (simultaneously selling dollars), and then wait for the exchange rate to rise. So you make the trade to buy 100,000 Euros you pay 146,190 dollars (100,000 x 1. 4619). Remember, at 2% margin (501 leverage), your initial margin deposit would be approximately $2,923 for this trade. As you expected, Euro strengthens to 1.462326. Now, to realize your profits, you sell 100,000 Euros at the current rate of 1.4623, and receive $146,230 You bought 100k Euros at 1.4619, paying $146,190. Then you sold 100k Euros at 1. 4623, receiving $146,230. That's a difference of 4 pips, or in dollar terms ($14 6,190 - 146,230 = $40). Total profit = US $40. Now in the example, let's say that we once again buy EURUSD when trading at 1.46 1619. You buy 100,000 Euros you pay 146,190 dollars (100,000 x 1.4619). However, Euro weakens to 1.461114. Now, to minimize your loses to sell 100,000 E uros at 1.4611 and receive $146,110. You bought 100k Euros at 1.4619, paying $146,190. You sold 100k Euros at 1.4611, receiving $146,110. That's a difference of 8 pips, or in dollar terms ($146,190 - $146,110 = $80) Total loss = US $80. ======================================================================= For ease of use, most online trading platforms automatically calculate the P&L o f a traders open positions. However, it is useful to understand how this calculat ion is derived. To illustrate a typical FX trade, consider the following example. The current bid/ask price for EUR/USD is 1.2320/23, meaning you can buy 1 euro w ith 1.2323 US dollars or sell 1 euro for 1.2320 US dollars. Suppose you decide that the Euro is undervalued against the US dollar. To execut e this strategy, you would buy Euros (simultaneously selling dollars), and then wait for the exchange rate to rise. So you make the trade: to buy 100,000 euros you pay 123,230 dollars (100,000 x 1 .2323). Remember, at 1% margin, your initial margin deposit would be $1,232 for this trade. As you expected, Euro strengthens to 1.2395/98. Now, to realize your profits, yo u sell 100,000 euros at the current rate of 1.2395, and receive $123,950.

You bought 100k Euros at 1.2323, paying $123,230. You sold 100k Euros at 1.2395, receiving $123,950. That s a difference of 72 pips, or in dollar terms ($123,950 $123,230 = $720). Total profit = US $720 (TIP: When trading EUR/USD or any Euro cross e.g. EUR/JPY, each pip is worth $10 , per 100,000 trade). =================================================================== When trading the forex market or other markets, we are often told of a common mo ney management strategy that requires that the average profit be more than the a verage loss per trade. It's easy to assume that such common advice must be true. However, if we take a deeper look at the relationship between profit and loss, it is clear that the "old," commonly held ideas may need to be adjusted. Tutorial: The Ultimate Guide To Forex Profit/Loss Ratio A profit/loss ratio refers to the size of the average profit compared to the siz e of the average loss per trade. For example, if your expected profit is $900 an d your expected loss is $300 for a particular trade, your profit/loss ratio is 3 :1 - which is $900 divided by $300. Many trading books and "gurus" advocate a profit/loss ratio of at least 2:1 or 3 :1, which means that for every $200 or $300 you make per trade, your potential l oss should be capped at $100. (For related reading, see Limiting Losses.) At first glance, most people would agree with this recommendation. After all, sh ouldn't any potential loss be kept as small as possible and any potential profit be as large as possible? The answer is, not always. In fact, this common piece of advice can be misleading, and can cause harm to your trading account. The blanket advice of having a profit/loss ratio of at least 2:1 or 3:1 per trad e is over-simplistic because it does not take into account the practical realiti es of the forex market (or any other markets), the individual's trading style an d the individual's average profitability per trade (APPT) factor, which is also referred to as statistical expectancy. The Importance of Average Profitability Per Trade Average profitability per trade (APPT) basically refers to the average amount yo u can expect to win or lose per trade. Most people are so focused on either bala ncing their profit/loss ratios or on the accuracy of their trading approach that they are unaware that a bigger picture exists: Your trading performance depends largely on your APPT. This is the formula for average profitability per trade: Average Profitability Per Trade = (Probability of Win x Average Win) - (Probabil ity of Loss x Average Loss) Let's explore the APPT of the following hypothetical scenarios: Scenario A: Let's say that out of 10 trades you place, you profit on three of them and you r ealize a loss on seven. Your probability of a win is therefor 30%, or 0.3, while your probability of loss is 70%, or 0.7. Your average winning trade makes $600 and your average loss is $300.

In this scenario, the APPT is: (0.3 x $600) (0.7 x $300) = - $30 As you can see, the APPT is a negative number, which means that for every trade you place, you are likely to lose $30. That's a losing proposition! Even though the profit/loss ratio is 2:1, this trading approach produces winning trades only 30% of the time, which negates the supposed benefit of having a 2:1 profit/loss ratio. (For related reading, see The Importance Of A Profit/Loss Pl an.) Scenario B: Now let's explore the APPT of a trading approach that has a profit/loss ratio of 1:3, but has more winning trades than losing ones. Let's say out of the 10 trad es you place, you make profit on eight of them, and you realize a loss on two tr ades. Here is the APPT: (0.8 x $100) (0.2 x $300) = $20 In this case, even though this trading approach has a profit/loss ratio of 1:3, the APPT is positive, which means you can be profitable over time. Many Ways of Becoming Profitable When trading the forex market, there is no one-size-fits-all money management or trading approach. Traditional advice, such as making sure your profit is more t han your loss per absolute trade, does not have much substantial value in the re al trading world unless you have a high probability of realizing a winning trade . What matters is that your APPT comes up positive and that your overall profits are more than your overall losses. For more forex money management tips, see Money Management Matters. by Grace Cheng Grace Cheng is a forex trader, creator of the PowerFX Course and author of "7 Wi nning Strategies for Trading Forex" (2007, Harriman House). This revealing book explains how traders can use various market conditions to their advantage by tai loring a strategy to suit each one. The book is a perfect complement to the Powe rFX Course. The PowerFX Course, designed for both new and current traders, teach es tools and trading approaches that combine technicals, fundamentals and the ps ychology of trading forex. It also includes Grace's proprietary tips and tricks. Grace's works have been published in The Trader's Journal, Technical Analysis o f Stocks & Commodities, Smart Investor and other leading trading/investment publ ications. Read more: http://www.investopedia.com/articles/forex/07/profit_loss.asp#ixzz1P2 OaY6l2