Understand the Trading Concepts
Market price
The value of the base currency in terms of the quote currency is called exchange rate or market price.
The exchange rate of 1.19500 for EURUSD means 1 Euro would cost 1.19500 US dollars. In other words, to own 1 Euro, the equivalent of 1.19500 US dollars should be paid.
Base currency
Quote currency
Market price
Base currency
Market price
Quote currency
Pip and tick
Point in price, or pip for short, is the smallest unit of a price change that any given exchange rate can make.
Most currency pairs are quoted to five decimal places which the fourth decimal place refers to as a pip.
The pairs include Japanese Yen are the exception. Their prices are measured to three decimal places, and the pip corresponds to the second decimal digit.
For CFDs, the minimum price movement is called a tick. Tick size varies for different CFDs depending on the type of CFD and its provider found in the contract specification.
- CFDs on gold, US oil, and UK Brent are quoted to two decimal places and the second decimal digit known as a tick.
- CFDs on silver, natural gas, and Litecoin are priced to three decimal places, and the third decimal place refers to as a tick.
- CFDs on indices and bitcoin are measured to one decimal place that is the minimum unit of price movement.
EURUSD
| Ask | Bid | Spread |
|---|---|---|
| 1.19510 | 1.19500 | 0.00010 1 pip |
Spread
The difference between the ask price and the bid price is known as spread representing the cost of trading. For instance, if EURUSD is trading with an ask price of 1.19510 and a bid price of 1.19500, the spread is 0.0001, equal to one pip.
Profit (loss) calculation
Now that you understand pip and lot, it's time to calculate profits and losses in quote currency, which simply is the amounts traded multiply by the change in pips.
For instance, if you open a buy position of 1 lot EURUSD at 1.18650 and close your position at 1.18775, you will profit 0.00125 or 12.5 pips that in this case, it is equal to €100,000 * 0.00125 = $125
in the base currency
in the quote currency
100,000
In CFDs, the profit (loss) is calculated by multiplying the units traded by the change in dollar per unit.
For example, if you open a sell position of 1 lot gold at 1795.00 and close it at 1791.50, you will earn $3.5 per ounce. As one lot of gold is equal to 100 ounces, your profit here will be 100 * 3.5 = $350
In USD
In USD
100
Leverage
Leverage is a loan provided by the broker to the traders that increases their trading capital to control bigger positions than their initial balance. If you deposit €5000 to your trading account with the leverage of 1:100, your trading capital will increase by 100 times to €500,000.
In this case, if you buy five lot EURUSD and profit 100 pips, you will earn €500,000 * 0.0100 = $5000, which means you will almost double your capital. If you lose 50 pips on your trade, you will lose €500,000 * 0.0050 = $2500, which costs you to lose about half of your money.
€5,000
Margin
Since the trader uses leverage, the broker requires the amount of money as collateral called margin to ensure that all potential losses will be covered. Dividing one by leverage multiplying by 100 gives the margin percentage. The required margin is the amount of trade multiply by margin percentage.
For example, for a trading account of $500 and the leverage of 1:100, the required margin for an open position is 1%. For opening a buy position of 2 lots EURUSD at 1.1950, the margin required to keep this position open is calculated like this: €200,000 * 1.1950 * 1% = $2390
In quote currency
In base currency
$239,000
Balance and equity
The balance refers to the sum of the funds you have in your trading account, including all profits and losses from closed positions. In other words, your balance is changed depends on the profits or losses from your trades once you close them.
Equity refers to your balance plus any profit or loss from your open positions. When you don't have any open position, your equity equals your balance. For instance, if your position of 2 lot EURUSD goes into the profit of $390, your balance will still be $5000, but your equity is calculated like $5000 + $390, which is equal to $5390.
Once you close your positions, your balance changes by the sum of the profits you have made to $5390, as you don't have any open position, your balance equals your equity.
From open positions
$5,390
Balance ± profit(loss)
$3000
Free margin and margin level
The amount of money in your trading account available for trading is called free margin, which is calculated by subtracting the margin of open positions from equity. Back to our example, for the account balance of $5000 with the open position of 2 lots EURUSD using the margin of 1%, if your trade goes into $390 profit, the available money in your account for trading would be $5000 + $390 - $2390 = $3000.
The margin level is a ratio of equity to the margin in terms of percentage. This ratio specifies the health of your account due to your open positions. A margin level of 100% means that your equity equals your margin, so you don't have any free margin to open a new position. In other words, the higher than 100% of the margin level, the healthier your account is. In the example above, the margin level is calculated like this (5390 / 2390) * 100, which is equal to 225%.
Margin call and stop out
The margin call level is a fixed percentage of the margin level, which alerts you to deposit more money to meet the required margin or, alternatively, close some of the least profitable positions to free up margin. For example, If your equity falls below 50% of your used margin because of the floating losses of your open positions, the broker will notify you on your devices to free up some margin. If the margin level keeps falling, the stop out will be triggered at a preset margin level of 20%.
Stop out is the percentage of margin level at which the least profitable positions will get closed automatically by the broker to back your margin level to 100% and protect you from losing more money than your deposit.
Margin call and stop out are determined by the broker and vary in different trading accounts.
Swaps in forex
In the simplest definition, swaps in forex refer to the interest fee charged on your account for keeping a trade overnight. There are two types of swaps. Swaps on short positions called swap shorts, and swaps on long positions called swap long. When you hold a trade open overnight, you may either earn or pay swap fees, depends on the difference in interest rate between the base currency and the quote currency. Swap fees are expressed in pips per lot and stated in a contract specification of each instrument.
Let's say EURUSD has a swap short of -0.01 and swap long of -0.67 pips per lot. If you go short on one lot EURUSD on Tuesday and close your position on the day after. The swap is calculated like this: €100,000 * (0.0001 * 0.01) * 1 night = - $0.1 or 10 cents. If you keep your position till the following Tuesday, your account will be charged for seven nights.
€ 100,000
It's important to note that positions held on Wednesdays will be charged the weekend swaps as well. Back to the example, if you open a position on Tuesday and close it on the following Thursday, it remains open for two nights, but on Wednesday midnight, the weekend swaps are applied as well, charging you for four nights.