How to Profit from Currency Exchange Trading

The profit you will gain or the loss you will incur from a currency trade is determined by the pip. A pip represents the smallest step by which a currency's price moves in either direction. Depending on the currency pair the value of the pip varies. Additionally, the exchange rate of the currency pair represents a factor influencing the pip value.

When there is an open position, depending on the currency you have bought or sold, an upward or downward movement of the pip determines the occurrence of a profit or loss. A fixed value of $10 is set when the US dollar is the counter (quote) currency. On the other hand, if the US dollar is the base currency, the pip value varies in accordance with the current market rates.

Estimating Pip Value

If you use the services of a trustworthy broker, then the option of getting real time information on the profits and losses from currency trades can be provided. It is recalculated every time the exchange rate changes. However, in order to get the best of this information, you should gain knowledge on how the actual calculations are done.

Depending on the base currency, the following calculations are executed.

Case 1: The base currency is the US dollar

For USD/CHF the current exchange rate is 1.1782. This means that one dollar is equal to 1.1782 Swiss francs. Thus, the value of $100,000 is equal to 117,820 Swiss francs. An increase of the pip value by one will result in a market price of 1.1783. This will lead to $100,000 being worth 117,830 Swiss francs.

Therefore, a one pip movement is worth 10 Swiss francs for 100,000 units of currency. In order to get the value of 10 Swiss francs at the new price you should divide 10 by 1.1783 (the new price). The result obtained is that 10 Swiss francs = $8.49. How is this result interpreted? If the trader decides to sell at this value, then s/he gets $8.49 profit for the 10 Swiss francs obtained.

Case 2: The counter currency is the US dollar

For EUR/USD the current exchange rate is 1.3616. This means that one euro is equal to $1.3616. Thus, the value of 100,000 euros is equal to $136,160. An increase in the pip value by one will result in a market price of 1.3617. This will result in 100,000 euros being worth $136,170.

If the trader likes the new price level, s/he may choose to close the position and sell the currency pair. S/he will pocket a profit of $10. However, if the trader has instead decided to sell the initial 100,000 euros at the price of 1.3616 and eventually the price has increased by one pip, then s/he would incur a loss of $10 the minute s/he chooses to close the position.

Making a Profit from the Exchange Rate Movement

Case 1: Making a profit from a rising exchange rate

The following example provides an illustration of how profits can be gained from an increasing exchange rate.

John is a trader, who has decided that he is able of making a successful speculation with the currency pair EUR/USD. He believes that the value of the EUR is about to increase relative the value of the USD. This means that the exchange rate of this currency pair is to increase. As a result he buys EUR/USD pair at the current market price of 1.3616.

John will speculate on the value of 100,000 EUR in relation to the USD.

As mentioned above, the current market value of EUR/USD is 1.3616. Thus, 1 EUR is worth $1.3616. The corresponding value of 100,000 EUR is $136,160. When the transaction is finished, John will have to repay the amount of $136,160, which he has borrowed.

If John's expectations of an increased value of the EUR come true and it increases by 50 pips, then the new market rate will be 1.3666. At this higher market rate, John can choose to close the position and not only pay back his $136,160, but also obtain a profit.

The initial 100,000 EUR will be now worth 136,660. After repaying his debt, John will be left with $500, which represents his profit.

Case 2: Making a profit from a falling exchange rate

Profiting is not limited only to rising exchange rates of currencies. However, a clear determination of the exact currency pair to be traded should be made.

Let's refer to our previous example and explore the case in which the value of the EUR is expected to fall relative to the value of the USD. Under these conditions, John should order the selling of the EUR/USD pair.

John should borrow euros in order to purchase US dollars. With the proceeds he gets from the borrowing of 100,000 euros, he will be able to purchase US dollars.

From our previous example, 1 euro is equal to $1.3616. Thus, the borrowed 100,000 euros purchase 136,160 USD. The amount the trader has borrowed for the purposes of executing the transaction will be repaid when it is finished.

If the value of the EUR really falls by, let's say, 50 pips, then the new market rate of EUR/USD will be 1.3566. At this new exchange level, John may decide to close the position and pocket the profit. He will have to repay the borrowed 100,000 euros, which have now decreased in value to $135,660. In order to get the acquired profit of $500, 135,660 are deducted from the initial value of the debt, namely 136,160.