Thursday, March 26, 2015

Calculating profit and loss with pips

Profit-and-loss calculations are pretty straightforward in
terms of math — they’re all based on position size and the
number of pips you make or lose. A pip is the smallest increment
of price fluctuation in currency prices. Pips can also be
referred to as points; we use the two terms interchangeably.
Looking at a few currency pairs helps you get an idea what a
pip is. Most currency pairs are quoted using five digits. The
placement of the decimal point depends on whether it’s a JPY
currency pair, in which case there are two digits behind the
decimal point. All others currency pairs have four digits
behind the decimal point. In all cases, that last itty-bitty digit
is the pip.
Here are some major currency pairs and crosses, with the pip
EUR/USD: 1.2853
USD/CHF: 1.2267
USD/JPY: 117.23
EUR/JPY: 150.65
Focus on the EUR/USD price first. Looking at EUR/USD, if the
price moves from 1.2853 to 1.2873, it’s just gone up by 20 pips.
If it goes from 1.2853 down to 1.2792, it’s just gone down by 61
pips. Pips provide an easy way to calculate the P&L. To turn
that pip movement into a P&L calculation, all you need to
know is the size of the position. For a 100,000 EUR/USD position,
the 20-pip move equates to $200 (EUR 100,000 × 0.0020 =
$200). For a 50,000 EUR/USD position, the 61-point move translates
into $305 (EUR 50,000 × 0.0061 = $305).
Whether the amounts are positive or negative depends on
whether you were long or short for each move. If you were
short for the move higher, that’s a – in front of the $200, if
you were long, it’s a +. EUR/USD is easy to calculate, especially
for USD-based traders, because the P&L accrues in dollars.
If you take USD/CHF, you’ve got another calculation to make
before you can make sense of it. That’s because the P&L is
going to be denominated in Swiss francs (CHF) because CHF is
the counter currency. If USD/CHF drops from 1.2267 to 1.2233
and you’re short USD 100,000 for the move lower, you’ve just
caught a 34-pip decline. That’s a profit worth CHF 340 (USD
100,000 × 0.0034 = CHF 340). Yeah but how much is that in real
money? To convert it into USD, you need to divide the CHF
340 by the USD/CHF rate. Use the closing rate of the trade
(1.2233), because that’s where the market was last, and you
get USD 277.94.
Even the venerable pip is in the process of being updated as
electronic trading continues to advance. Just a couple paragraphs
earlier, we tell you that the pip is the smallest increment
of currency price fluctuations. Not so fast. The online
market is rapidly advancing to decimalizing pips (trading in
1⁄10 pips) and half-pip prices have been the norm in certain
currency pairs in the interbank market for many years.

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