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# Forex Trading Examples (part 4)

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### Example 23

When you close out a trade, you can calculate your profits and losses using the following formula:

Price (exchange rate) when selling the base currency's price when buying the base currency X transaction size = profit or loss
Assume you buy Euros (EUR/USD) at 1.2178 and sell Euros at 1.2188. If the transaction size is 100,000 Euros, you will have a \$100 profit.

(\$1.2188 - \$1.2178) X 100,000 = \$.001 X 100,000 = \$100
Similarly, if you sell Euros (EUR/USD) at 1.2170 and buy Euros at 1.2180, you will have a \$100 loss.

(\$1.2170 - \$1.2180) X 100,000 = - \$.001 X 100,000 = - \$100
You can also calculate your unrealized profits and losses on open positions. Just substitute the current bid or ask rate for the action you will take when closing out the position. For example, if you bought Euros at 1.2178 and the current bid rate is 1.2173, you have an unrealized loss of \$50.

(\$1.2173 - \$1.2178) X 100,000 = - \$.0005 X 100,000 = - \$50
Similarly, if you sold Euros at 1.2170 and the current ask rate is 1.2165, you have an unrealized profit of \$50.

(\$1.2170 - \$1.2165) X 100,000 = \$.0005 X 100,000 = \$50
If the quote currency is not in US dollars, you will have to con- vert the profit or loss to US dollars at the dealer's rate. Further, if the dealer charges commissions or other fees, you must subtract those commissions and fees from your profits and add them to your losses to determine your true profits and losses.

### Example 24

The formula for calculating the security deposit is:

Current price of base currency X transaction size X security deposit % = security deposit requirement given in quote currency
Returning to our Euro example with an initial price of \$1.2178 for each Euro and a transaction size of 100,000 Euros, a 1% security deposit would be \$1,217.80.
\$1.2178 X 100,000 X .01 = \$1,217.80

Security deposits allow customers to control transactions with a value many times larger than the funds in their accounts. In this example, \$1,217.80 would control \$121,780 worth of Euros.
Value of Euros = \$1.2178 X 100,000 = \$121,780

This ability to control a large amount of one currency, in this case the Euro, using a very small percentage of its value is called leverage or gearing. In our example, the leverage is 100:1 because the security deposit controls Euros worth 100 times the amount of the deposit.

Since leverage allows you to control large amounts of currency for a very small amount, it magnifies the percentage amount of your profits and losses. A profit or loss of \$1,217.80 on the Euro trans- action is 1% of the full price (with leverage of 1:1) but is 100% of the 1% security deposit. The dollar amount of profits and losses does not change with leverage, however. The profit or loss is \$1,217.80 whether the leverage is 100:1 or 25:1 or 1:1.

### Example 25

The following examples illustrate long and short positions, the benefits and risks of margin trading and the workings of the margin account.

Going Long

Assume that you start with a clean slate and that the current GPB/USD ("cable") rate is 1.5847/52.

You expect the pound to appreciate against the US dollar, so you buy a single lot of 100,000 GBP at 1.5852 USD.

The value of the contract is 100,000 X 1.5852 USD = 158, 520 USD. The broker wants margin of 2.5% in USD, so you must ensure that you deposit at least 2.5% of 158,520 USD = 3,963 USD in your margin account

GBP/USD appreciates to 1.6000/05 and you decide to close out by selling your sterling for US dollars at the bid rate. Your gain is:
- 100,000 X (1.6000 – 1.5852) USD = 1,480 USD

Your rate of return is 1,480/3,963 = 37.35%, on an exchange rate movement of less than 1%. This illustrates the positive effect of buying on margin.

100,000 X (1.5852 – 1.5700) USD = 1,520 USD, a return of –38.35% illustrating the disadvantage of margin trading.

### Example 26

Going Short

You expect sterling to fall from GBP/USD = 1.5847/52 so you decide to sell one lot of GBP/USD.
The value of the contract is 100,000 X 1.5847 USD = 158,470 USD.
Your broker requires 2.5% of 158,470 USD as margin = 3,961.75 USD in cash
GBP/USD falls to 1.5555/60 and you are sitting on a paper gain of: -
100,000 X (1.5847 – 1.5560 USD) = 2,870 USD

Your 2,870 USD paper gain is credited to your margin account ("variation in margin") where you now have 6,831.75 USD. This enables you to maintain open positions worth 273,270 USD

GBP/USD starts to rise. When it reaches 1.6000/05, you are sitting on a paper loss of:
100,000 X (1.6005 – 1.5847) USD = 1,580 USD.

Your margin account is debited by 1,580 USD ("variation in margin"), taking it down to 2,381.75 USD which is sufficient to support 2,381.75 USD/0.025 = 95,270 USD worth of open positions. Your current exposure, however, is:
100,000 X 1.6005 USD = 160,050 USD
Your "shortage in equity" is therefore 160,050 USD - 95,270 USD= 64,780 USD
The broker makes a margin call for 2.5% of 64,780 USD = 1,619.50 USD.

You eventually close out your position at GBP/USD = 1.5720/25. Your gain is:
100,000 X (1.5847 – 1.5725) USD = 1,220 USD.
You have no more open positions, so you can withdraw the full 5,181.75 USD from your trading account in cash. Alternatively, you have enough margin to support 207,270 USD worth of new positions.

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