BUYING AND SELLING IN DETAILS

Now that you have learned the basics and technical terms, we can discuss how buying and selling work in the Forex market by using the terms you just learned earlier. 

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To fully understand this topic, you must know what a pip is and how to calculate it, what is meant by a Lot, leverage, bid, ask and spread. 

 

As discussed before, the aim of forex trading is simple. Like any other form of speculation, you want to buy a currency at one price and sell it at a higher price (or sell a currency at one price and buy it at a lower price) to make a profit.

 

Currency appreciation is an increase in the value of one currency to another currency. On the other hand, currency depreciation is a decrease in the value of one currency in relation to another currency.

 

Generally speaking, If you think a currency is going to depreciate, then you sell it. But, conversely, If you think that a currency is going to appreciate, you buy it. 

 

Let's take a look at this example:

 

Assume you have a USD-based trading account with a leverage of 100:1 that has 1000 US dollar capital in it. 

 

Your analysis tells you that Euro is undervalued relative to the US dollar. You see an opportunity that Euro could appreciate against the US dollar in the short term, roughly around ten pips. Therefore, you decide to buy the Euro and wait till a ten-pip rise happens against the US dollar by risking only five pips. 

But to calculate your profit and loss in order to manage your risk before you place your trade, you need to know a few things:

 

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1) Pip value of EUR/USD for your USD based account:

 

$0.10 for a micro lot (1,000)

$1 for a mini lot (10,000)

$10 for a standard lot (100,000)

Let's assume you decide to open a standard lot. 

 

2) Commission charged by the broker

 

Let's assume your broker charges no commission. 

 

 

3) Bid, Ask, and spread 

 

Let's assume your account is a fixed spread account, and the spread on EUR/USD is fixed at one pip (0.0001).

 

1.1350-1.1349= 0.0001 (Spread)

 

Now that you know all the required information, assuming the current exchange rate is 1.1350, you can calculate your profit and loss if you decide to get in at this rate. It is important to do that in order to calculate your risk exposure and manage your trade size according to your risk tolerance. Thus, below is the pre-calculated potential net profit and loss of your trade:

 

• Rate after a 10 pip rise: 1.1350 + 0.0010

• Potential profit: (1.1360-1.1350)*100,000= 100 US dollar 

• Cost: 0.0001*100,000= 10 US dollar

 

Net Profit: 100-20= 90 Dollar 

 

• Rate after a 5 pip decrease: 1.1350 - 0.0005 = 1.1345

• Potential loss: (1.1350-1.1340)*100,000= 50 US dollar 

• Cost: 0.0001*100,000= 10 US dollar

 

Net Loss= 50+10= 60 Dollar

 

 

Now let's take a look at the two trade examples on USD/CHF for a better understanding of profit and loss calculations.

 

 

1. Analysis: Let's assume that your analysis signals that the US Dollar will appreciate in value against the Swiss Franc. 

2. Action: Therefore, you go ahead and buy 1 standard lot (100,000 units) of USD/CHF at the exchange rate of 1.0030 (ask rate), and you receive US$ 100,000, which is worth CHF 100,300 at the exchange rate of 1.0030. 

3. Result: Now, let's assume your prediction was right, and the USD appreciated against CHF, and the exchange rate became 1.0070, or to put it differently, the exchange rate rose by 40 pips.

4. Execution: Thus, due to the rise in the exchange rate, you decide to exit (sell) and close your position. Thus, you sell the US$ 100,000 that you bought earlier at the new exchange rate (Bid rate) of 1.0070 and receive 100,700 of Swiss Franc (100,000 x 1.0070). 

5. Conclusion: Ignoring the cost of trading such as spread and commissions, you profit CHF 400 (100,700-100,300).