Calculating P&L in Forex Trading

Profit and loss - global prime

The most important measure of your performance as a trader is the profit or loss that you achieve. Period. At the end of the day, this is what really matters, although the way you achieve a certain return is equally important, a trader should always keep the big picture in mind, meaning his/her overall P&L, when making trading decision. One of the key points to remember is that you are making an investment decision even when you have no position (being in cash is a position!), or you are just holding on to long-term trades.

In order to keep things in perspective, you have to have a clear understanding of how your profits are calculated before you take a position on. Position sizing is one of the basic risk management tools, and when dealing with forex pairs, determining the right size to trade with might prove trickier than in the case of other assets. Why? All the different measures and concepts you will stumble upon might be confusing, like lot sizes, margin, swap rates, and so on. The way forex prices are quoted makes it much harder to keep track of your profits, especially if you are not in front of your primary trading interface.

Modern forex trading platforms make it very easy to follow your actual P&L, but it is vital for a trader to be able to determine the possible profits and losses before establishing a position. Although some platforms will help you by displaying your exact exposure before executing a trade, its best is to know and understand the basics to get a feel of how big a position will be relative to your comfort level and account size.

Calculating your position size and pip value

The ideal position size is different for everyone, but the calculation method is obviously the same. The basic size that was used “back in the day” was the standard lot. That is 100,000 units of a currency. As an example, 1 lot of EUR/USD is the equivalent of a 100,000 USD position. Nowadays it is possible to trade with less than 1 lot. When trading 0.1 lot or 10,000 units of a currency you can say that you are trading one mini-lot. A micro-lot, on the other hand, is 0.01 lot or 1,000 units of a currency.  In order to know your exact position size, you have to know what unit your broker uses to display your exposure. Most brokers still use the standard lot as the basic unit, so if you have a 0.1 exposure to EUR/USD you have a 10,000 USD position.

What does that mean to your P&L? Well, that’s where pip value comes in. As the movement in forex markets are normally measured in pips (“1/10,000th of a single unit of currency for all pairs except JPY pairs which are 1/100th of a unit of JPY”) it is good to know what the effect one pip has on your profits.

When you have a 1 standard lot position in our example, it is easy to see that 1 pip equals 10 USD whereas 1% (or 100 pips) move will mean a profit or loss of 1000 USD depending on your position. With the same logic, one mini-lot means a pip value of 1 USD while a micro-lot gives you a pip value of 10 cents.

Know your exposure!

Now that you are equipped with the concept of pip value it is up to you to actually know what your position is. While that might sound simple, it can be confusing if you open multiple positions in a pair. While in a practical matter having one position that equals an aggregate of numerous positions shouldn’t matter, it might actually account for a hefty fee because more positions mean more trades, and thus more. These costs might make a huge difference for an active trader or scalper.

So, for one pair it is quite simple, your overall exposure will depend on how many lots you hold. Now, remember that your exposure is always relative to your amount of capital. The same position might be irrelevant for someone or be overkill for another trader. How will you know if your position size is optimal for you or not? To answer that you have to determine your strategy or the time-frame you trade on as well as the money management and risk management principles you will incorporate in to your strategy.

The role of P&L in these methods is simple; it gives you the input of what a move would mean to your portfolio. It’s a basic yet very important step.

Let’s move on to the case of having multiple positions!

Aggregating positions in different pairs

If you trade or hold positions in more than one pair the calculation of your exposure gets a bit trickier, thanks to the complicated correlations, your actual P&L numbers shouldn’t cause you problems. The only thing that you have to be aware of is the role of the pair denominated in different currencies. This is especially true if the pairs are not “normalized” to the same magnitude.

What does that mean? There are some brokers out there who don’t account for the different nature of Japanese Yen (or other “cheap”) based pairs. That could lead to major misunderstandings, because you need 100 times more nominal Yen exposure to have the same position size than in the case of other major currencies. It is quite common that a trader ends up with a much smaller position than intended because of this fallacy.

So, if you have accounted for the currency differences, your aggregate P&L is simply the sum of the individual P&L numbers. That said, you have to differentiate between daily profits and overnight profits for both open and closed positions. Some platforms display both, and that could lead to confusions, since, of course, when evaluating a position you should consider the overall P&L not just the latest day’s profits.

If the enormity of calculating the P&L across all your positions has sent you reeling, then fear not. Thankfully, platforms like MT4 accurately aggregates your overall P&L and takes into account additional costs like commissions, spreads and swaps… Read on to learn more!

Paper profits and realized profits

A common error (or sometimes a dangerous psychological trap) is to differentiate between paper profits (unrealised profits) and realised profits. To have a realistic and conservative view of your portfolio you should always account for all your closed and open positions including the costs (spread and commission) of closing the open ones.

“Mental accounting” is a real threat, as ignoring a losing position or transforming a day-trade into a long-term investment (it will come back!) is one of the primary causes of margin calls among retail traders.

So, remember that all your positions count, no matter how you try to rationalise them!

The role of leverage

The fine print: commissions, spreads, and swaps…

Magnifying Glass

We have already talked a bit about the role of costs in the overall P&L, but let’s sum up the key concepts! First, spreads and commissions are mostly interchangeable from the trader’s perspective. (There are instances when one has a more important role, such as the spread in the case of illiquid pairs), but basically, you should account for both when assessing their effects on your P&L. Don’t be fooled by zero spread promotions or no commission brokers, pay attention to all costs of trading.

If you hold long-term positions your P&L will also be affected by overnight or swap rates, which are dictated by the banks. This means that you have to pay (or sometimes you receive) the difference between the daily interest rates of the two currencies in the pair that you hold. With our prior example, the EUR/USD you receive the interest rate that applies for the Euro while you pay the interest charged for the USD.

In practice, given the current very low interest rates globally, this value is almost always negative, but it can differ substantially depending on the broker you choose. To get an idea about the exact value, most major currencies have interest rates of less than 1% on a yearly basis, so the day to day value is minuscule, but if you rely heavily on leverage and/or hold positions on the long run, it may add up to a meaningful sum.

Conclusion

To wrap the article up, here are the simple steps that you have to follow to calculate your P&L for any forex position

  1. Check your position size (example: LONG POSITION, 1 lot of EUR/USD at the price of 1.1500, the current price is 1.1550)
  2. Calculate the pip value of the position (the pip value is 10 USD)
  3. Calculate the difference of the initial price and the current price (or the closing price of the trade if the trade is closed) and multiply it with the pip value (the movement +50 pips: the difference: 500 USD)
  4. Deduct the commissions paid (assumed commission: 50 USD, the net profit:+450 USD)
  5. Convert the amount to your base currency (with an AUD account: 450 USD/0.75=600 AUD)
  6. You achieved profits if the number is positive and you have a long position, or the number is negative and you have a short position. (positive number and Long position: profits)
  7. If you have multiple positions repeat the process on all of them

As you can see, calculating your P&L is not a complicated process, but some caution is recommended as these calculations provide crucial input to your risk management, money management, and position sizing plans. Most modern platforms do the math automatically, but still, it’s good to be aware of these simple steps. And as always, demo accounts can help you in trying out the orders, sizes, and exact execution methods before using them in “real” trading. Use this opportunity to your advantage!

Safe trading!

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