It is relatively very simple to calculate the profit or loss from your Forex transactions. To calculate the profit from a trade you need to know the number of pips you have earned or lost, the numbers of contracts you have bought or sold, and how much each pip is worth. The difficult part is figuring out the pip value because Forex doesn’t have standardized trade sizes, and because many currency pairs are not quoted in terms of US Dollars.
Profit or loss = Number of pips * Pip value * Number of contracts
In a buy trade you make a profit if the closing price is higher than the opening price, otherwise, you’re incurring a loss. Conversely, in a sell trade, you make a profit if the closing price is lower than the opening price otherwise, you’re incurring a loss.
What is a Pip?
In order to trade successfully, you need to understand what a pip is. In simple terms, a PIP is simply an acronym for Percentage In Point and represents the smallest price change that a given exchange rate can make. Each increase or decrease in pips represents a profit or a loss in your trade.
Majority of currencies are quoted to the fourth decimal place (EUR/USD 1.1950) with exception being USD/JPY which is quoted to two decimal places (USD/JPY 110.25). When the EUR/USD exchange rate moves from 1.1950 to 1.1951 it has moved 1 pip because the fourth decimal point has increased by one.
How to Calculate the Pip Value
Nowadays, the majority of trading platforms are displaying how much the value of one pip represents so you won’t need to calculate it by yourself. However, it’s still good to know how to obtain the pip value.
When the US Dollar is the quoted currency, usually each pip equal $1for every lot traded ($10,000). So if you buy five lots each pip will be valued at $5.
Let’s have a look at an example: If you buy $100,000 ($10/pip) EUR/USD at the price of 1.1700 and then the EUR/USD exchange rate rallies 100 pips and you decided to sell your trade for a profit at 1.1800 you have earned $1000 = 100 pips x $10/pip.
In this case the pip value is $10 = 10 lots traded * $1.
When the US Dollar is the based currency, it’s slightly more difficult to calculate the pip value because of the cost of a pip floats. For example, if you bought $50,000 USD/CHF at the price of 0.9800 and then sold your position at 0.9850 you made a profit. Since the selling price is higher than the buying price means that you have made 50 pips profit (Closing Price 0.9850 – Opening Price 0.9800 = +50 pips).
Now, we need to calculate the value of one pip at the closing price of the trade 0.9850. Divide 1 by 0.9850 and we get $1.0204 for each pip.
The total profit in this case is: 50 x 5 x $1.0152 = $253.8
To make things simple when dealing with direct currency rates that have the US dollar as the based currency you can directly apply the following formula to determine the pip value:
Pip Value = (One Pip / Exchange Rate) * Lot size
Example: If we buy 1 standard lot ($100,000) USD/CAD at an exchange rate of 1.2500, each pip move in your favor will be worth $8.
Pip Value = (0.0001 / 1.2500) * 100.000 = 8 USD
Let’s assume that after we bought USD/CAD, the exchange rate drops 50 pips (1.2450) and hits our stop loss in which case we incur a loss of $450.
PnL = Pips Gained(Lost) * Pip Value * Lots Traded
PnL = -50 pips * $8 * 1 contract = -$450
If we’re dealing with cross rates that don’t involve the US Dollar you can directly apply the following formula to determine the pip value:
Pip Value = [(One Pip / Exchange Rate) * Lot size] *Base Currency Exchange rate
Example: If we buy 1 standard lot GBP/JPY at an exchange rate of 147.00, in order to calculate the pip value we’ll need the exchange rate of the Base currency, which in our case is the GBP/USD and we’ll use 1.3500 as our conversion exchange rate.
Pip Value = [(0.01 / 147.00) * 100.000] * 1.3500= 9.18 USD
So, for every 0.01 pip move in GBP/JPY, you’ll earn $9.18 if the exchange rate moves in your favor our lose $9.18 if the exchange rate moves against you.
Let’s assume you bought 5 contracts and close the trade once the GBP/JPY exchange rate reaches 150.00 capturing 300 pips. The next step is to apply our PnL formula to see our net dollar profits.
PnL = 300 pips * $9.18 * 5 contracts = $13,770
Part of your job as a trader is to know what your potential profit or loss is at any time. It’s also important to know the pip value before placing a trade because you don’t want to open trades that your account size can’t handle.