Unlike the stock, futures, or options markets, calculating profits in the foreign exchange market can be a bit more complex. This is because you have to transfer profits from the foreign currency you purchased back into your home currency.
This concept is best understood through an example. So, let's say you have 10,000 US dollars, and let's say the EURUSD is trading at 1.5000. This means that 1 euro buys you 1.5000 US dollars -- or, conversely, one US dollar buys you 0.667 euros (1 / 1.5 = 0.666). So, with your 10,000 US dollars, you are able to buy about 6,666.66 euros.
Now, let's say the EURUSD exchange rate jumps up to 1.5500 -- meaning that one euro can now buy you 1.5500 US dollars. Since the euro rose in value since you made your purchase, you can now sell your euros for more dollars than you initially purchased them with. In other words, you made a profit!
To realize your profit, all you need to do is convert the 6,666.66 euros you now have back into US dollars. Since one euro now buys you 1.5500 US dollars, you can simply multiple your quantity of euros -- 6,670 -- by the exchange rate (1.5500). The result is 10,333.33. So there you have it -- a profit of 333.33 US dollars!
Profiting By Selling a Currency (aka "Going Short")
Slightly more involved are transactions in which you go short -- in other words, in which you believe the exchange rate is going to fall. In such a scenario, what you are actually doing is borrowing the currency you believe is going to fall in value. So, let's say you borrow the equivalent of 10,000 US dollars when the EURUSD is trading at 1.5000. This means you have borrowed about 6,666.66 euros, and have used those borrowed funds to purchase 10,000 US dollars.
Now, let's assume the exchange rate falls to 1.4500, and you decide you want to exit the trade. To do this, you simply want to exchange the 10,000 US dollars you purchased back into euros at the new exchange rate. At a rate of 1.4500, your 10,000 US dollars buys you 6,896.55 euros. You now have to repay the original 6,666.66 euros you borrowed, leaving you with 229.89 euros. You then want to convert this back into US dollars -- your home currency -- which, at an exchange rate of 1.4500, amounts to 333.33. This is your profit from the trade.
As you can see, foreign exchange trades can be a bit more complex than your typical stocks or futures trade -- but if you take it step by step, you'll see it's really just a few straightforward math equations.
Simon Parth has been an active trader of currencies since 2002. He is a founding member of InformedTrades.com, a community dedicated to creating a free and comprehensive learning resource to help traders learn how to take advantage of opportunities in the world's financial markets.
This concept is best understood through an example. So, let's say you have 10,000 US dollars, and let's say the EURUSD is trading at 1.5000. This means that 1 euro buys you 1.5000 US dollars -- or, conversely, one US dollar buys you 0.667 euros (1 / 1.5 = 0.666). So, with your 10,000 US dollars, you are able to buy about 6,666.66 euros.
Now, let's say the EURUSD exchange rate jumps up to 1.5500 -- meaning that one euro can now buy you 1.5500 US dollars. Since the euro rose in value since you made your purchase, you can now sell your euros for more dollars than you initially purchased them with. In other words, you made a profit!
To realize your profit, all you need to do is convert the 6,666.66 euros you now have back into US dollars. Since one euro now buys you 1.5500 US dollars, you can simply multiple your quantity of euros -- 6,670 -- by the exchange rate (1.5500). The result is 10,333.33. So there you have it -- a profit of 333.33 US dollars!
Profiting By Selling a Currency (aka "Going Short")
Slightly more involved are transactions in which you go short -- in other words, in which you believe the exchange rate is going to fall. In such a scenario, what you are actually doing is borrowing the currency you believe is going to fall in value. So, let's say you borrow the equivalent of 10,000 US dollars when the EURUSD is trading at 1.5000. This means you have borrowed about 6,666.66 euros, and have used those borrowed funds to purchase 10,000 US dollars.
Now, let's assume the exchange rate falls to 1.4500, and you decide you want to exit the trade. To do this, you simply want to exchange the 10,000 US dollars you purchased back into euros at the new exchange rate. At a rate of 1.4500, your 10,000 US dollars buys you 6,896.55 euros. You now have to repay the original 6,666.66 euros you borrowed, leaving you with 229.89 euros. You then want to convert this back into US dollars -- your home currency -- which, at an exchange rate of 1.4500, amounts to 333.33. This is your profit from the trade.
As you can see, foreign exchange trades can be a bit more complex than your typical stocks or futures trade -- but if you take it step by step, you'll see it's really just a few straightforward math equations.
Simon Parth has been an active trader of currencies since 2002. He is a founding member of InformedTrades.com, a community dedicated to creating a free and comprehensive learning resource to help traders learn how to take advantage of opportunities in the world's financial markets.
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