The word FOREX is derived from the words Foreign Exchange and is the largest financial market in the world. Unlike many markets the FX market is open 24 hours per day and has an estimated $1.2 Trillion in turnover every day.

This tremendous turnover is more than the combined turnover of the main worlds’ stock markets on any given day. This tends to lead to a very liquid market and thus a desirable market to trade.

The Foreign Exchange market, also referred to as the “Forex” or “FX” market is the largest financial market in the world, with a daily average turnover of well over US$1 trillion-30 times larger than the combined volume of all U.S. equity markets.

“Foreign Exchange” is the simultaneous buying of one currency and selling of another. Currencies are traded in pairs, for example Euro/US Dollar (EUR/USD) or US Dollar/Japanese Yen (USD/JPY).

There are two reasons to buy and sell currencies. About 5% of daily turnover is from companies and governments that buy or sell products and services in a foreign country or must convert profits made in foreign currencies into their domestic currency. The other 95% is trading for profit, or speculation.

For ease of use, most online trading platforms automatically calculate the P&L of a traders’ open positions. However, it is useful to understand how this calculation is derived.

To illustrate a typical FX trade, consider the following example.

The current bid/ask price for USD/CHF is 1.2622/1.2627, meaning you can buy $1 US for 1.6327 Swiss Francs or sell $1 US for 1.2622.

Suppose you decide that the US Dollar (USD) is undervalued against the Swiss Franc (CHF). To execute this strategy, you would buy Dollars (simultaneously selling Francs), and then wait for the exchange rate to rise.

So you make the trade: purchasing US$100,000 and selling 126,270 Francs. (Remember, at 1% margin, your initial margin deposit would be $1,000.)

As you expected, USD/CHF rises to 1.2735/40. You can now sell $1 US for 1.2735 Francs or buy $1 US for 1.2740 Francs.

Since you’re long dollars (and are short francs), you must now sell dollars and buy back the francs to realize any profit.

You sell US$100,000 at the current USD/CHF rate of 1.2735, and receive 127,350 CHF. Since you originally sold (paid) 126,270 CHF, your profit is 1080 CHF.

To calculate your P&L in terms of US dollars, simply divide 1080 by the current USD/CHF rate of 1.2735.

Total profit = US $848.05

Source by Martin Chandra