Question : is this a paradox?

Hello people,

I am thinking what if such an extremely conditions is happening to the currency pair and then I get confused about this :

Assume that we start trading with capital like 10 000 USD,
and at that time when USDCHF is trading at 1.0000 we go long for 0.1 standard lots (10 000 units) which means we are using 1 : 1 leverage (or no leverages at all?). Then, something terrible is happening, and USDCHF crashed into 0.5000,
at this point our unrealized profit/loss is -10 000 USD, which means we are totally out of the game, right? Do you guys spot something is not right? please show me! if nothing is wrong with my statement, do you guys feel something strange? How we can lose all of our funds when we are not using any leverage at all? please set things right

Editing this post to correct the issue.

The denominator currency is used to calculate leverage .
Hence true leverage in your USD acct is 1:2 in above post.

Of course you can lose all your money even if you are not using leverage. Why not? Leveraging up just means you'll get stopped out earlier if you don't intervene in the trade at all.

But in your example you would have lost 5000 USD.

5000 pips, 1 mini lot (10.000) is 1 USD per pip

The only paradox for me is your strange question.

the lose is not 5000$, but 5000 chf = 5000 / 0.5 = 10 000 USD

CHF/USD pair would be 1:1 leverage on USD acct.

On usd/chf it is 1:2 leverage.

You wrote the account's balance is 10.000 USD

So your loss will be in dollars and not in francs.

Closing the position will not turn your account balance into CHF.

Exact math of it:

Quote of pair == USD/CHF

Meaning the quote says: $1 USD buys $X CHF

Example: Current quote is ~ 0.91231 on the USD/CHF

So $1 USD buys 0.91231 Swiss Francs

(this is also why we quote Yen in such high numbers, since $1 USD buys a lot of Yen... makes a lot of sense for higher denominated currencies like that..)


SO... as per the thread poster's example, let's assume that the Franc is trading at parity. ie, USD/CHF is now quoting at $1 even


We have a $10,000 USD account. We open one mini-lot with a total trade value of $10,000 USD (trade value and lot sizes are always set in the first currency of a pair, this is why the margin requirement when you trade EUR/USD aren't exactly dead on if your account currency is in USD... since buying a mini-lot is buying 10k Euros, not dollars.)


So trade value is $10k USD, giving us an even $1 per pip movement.


The USD/CHF then falls to $0.50 (which means the Franc actually doubled in value vs the green back.)

Your long position is now 5000 pips in the red, at a rate of $1 USD per pip. The per pip amount doesn't change since your opening position hasn't changed (you still paid initially at parity, that fact doesn't change with the currency fluctuation.)

Now, since you were long on this pair, you sold $10k USD worth of CHF at parity to buy back $10k worth of USD. When you close this position, you'd have to pay back a debt of 10k CHF with the position's USD (not your account's balance but the position you opened.) BUT... since the exchange rate has changed, you're left short on your CHF debt (remember, using the leverage you borrowed in USD when you went long USD/CHF, that borrowed sum is what pays back the CHF side of the trade and your account balance only covers (or is credited) the difference beyond that.) Since the position is short by $5000, this difference comes from your account balance, and you take a loss.


You have an effective 1:1 leverage rate. You will only pay the difference in this case.



This really comes down to understanding exactly what takes place when you open and close a position and how currency pairs are quoted.


EUR/USD Long == Selling USD to buy EUR, and is closed by selling EUR at current market rates to cover the USD sold at first... netting the difference.

oh cmon...

Guys, we forex trader should have understood how money is made in this market. Otherwise, we should checkin' back to babypips, and I am seriously advocating that we should stay there as long as possible before we hand over our moneys to people.

Please check this out
http://www.babypips.com/school/lots-...-and-loss.html

Everything in my post above is in line with that link to babypips... They do a slightly better job of explaining it, but the info is the same.

EDIT:::

Actually, wait, I think I see where your confusion is coming from. The babypips article is calculating the net profit/loss based on the opening and closing rate as if the closing order affected the pip value of the opening order. This might send people thinking that the pip value changes the further away from the opening price you get... and that isn't quite what's happening when it comes to how your account P/L is accounted for with your broker.

let me point it clearly

How the heck do I calculate profit and loss?

So now that you know how to calculate pip value and leverage, let's look at how you calculate your profit or loss.

Let's buy U.S. dollars and Sell Swiss francs.
The rate you are quoted is 1.4525 / 1.4530. Because you are buying U.S. dollars you will be working on the "ask" price of 1.4530, or the rate at which traders are prepared to sell.
So you buy 1 standard lot (100,000 units) at 1.4530.
A few hours later, the price moves to 1.4550 and you decide to close your trade.
The new quote for USD/CHF is 1.4550 / 1.4555. Since you're closing your trade and you initially bought to enter the trade, you now sell in order to close the trade so you must take the "bid" price of 1.4550. The price traders are prepared to buy at.
The difference between 1.4530 and 1.4550 is .0020 or 20 pips.
Using our formula from before, we now have (.0001/1.4550) x 100,000 = $6.87 per pip x 20 pips = $137.40

I think I see where your confusion is coming from. The babypips article is calculating the net profit/loss based on the opening and closing rate as if the closing order affected the pip value of the opening order. This might send people thinking that the pip value changes the further away from the opening price you get... and that isn't quite what's happening when it comes to how your account P/L is accounted for with your broker.

Here:

The pip value isn't exactly $1 since the quote isn't the example you gave of parity, and instead is a current market rate. BUT...

http://i.imgur.com/bw8eB.png


Notice two things, the stop loss of 5000 pips down, and the result of 5000 pips of a loss.

The pip value doesn't change no matter how far it falls... it's 1:1 leverage in your example.

The Babypips site, while correct in some respects, is confusing you.

Woah... wait a tick...


something doesn't add up here... let me get back to you.

If babypips is confusing people, what about Oanda?

http://fxtrade.oanda.com/analysis/profit-calculator/how

You see that the rate for USD/JPY is 115.00/05 and decide to buy 10,000 USD. Your trade is executed at 115.05.

10,000 USD*115.05= 1,150,500 JPY

You bought 10,000 USD and sold 1,150,500 JPY.

The market rate of USD/JPY falls to 114.45/50. You decide to sell back 10,000 USD at 114.45.

10,000 USD*114.45=1,144,500 JPY

You bought 10,000 USD for 1,150,500 JPY and sold 10,000 USD back for 1,144,500 JPY. The difference is your loss and is calculated as follows: 1,150,500-1,144,500= 6,000 JPY. Note that your loss is in JPY and must be converted back to dollars.

To calculate this amount in USD:

6,000 JPY/ 114.45 = $52.42 USD or
6,000 *1/114.45=$52.42

Now I'm confused... lol...

I got mixed up for a moment. It would only be a $5000 loss should the base currency of the account itself be in CHF.

In USD, the loss is the full $10k USD, as per both babypips and Oanda's method of calculation.

I'm glad you brought this up... I'm a scalper and my average holding time on trades is only 8 minutes according to my stats, so I don't see 5000 pip gains or losses and thus have never tried to clarify on this difference...

That's it Jack...I'm glad you are now having the same tunes with me

So just had a chat with an Oanda support rep on about this very subject (since this directly affects a very practical application of trading that I plan on utilizing in the near future, I felt it was worth bugging them about it.)

(that and I've been sick the last two days so my tired and hazy mind really wanted a 2nd pair of eyes on this..)

I'll await the greater clarification via email... as the rep wasn't able to fully answer me this moment. Oanda has a good history of following up with people if they promise to email them later.. so I trust that I will hear back from them.

Couple of quick things: Always be nice to support reps no matter what the problem (even if you think they ripped you off... let alone asking a non-account related question as I have done here.) I've worked support jobs in the past and you have no idea how much you can get out of people by just being nice to deal with.

Please don't swamp them with the same question.. wait someone posts something here that clears this whole thing up.

And yes, my name isn't Jack in real life..

Chat Transcript

info: Please wait for an agent to respond.
info: You are now chatting with 'Crystal'

Crystal: Thank you for choosing OANDA. How may I help you?

Jonathon: hi
Jonathon: I'm trying to better understand how to calculate exposure and profit/loss
Jonathon: I'm a little confused
Jonathon: let's say I have a $1000 USD account
Jonathon: and I want to use a leverage of 1:1 (so not leveraged at all really) and expose myself short to the CHF (using usd/chf)
Jonathon: what size position should i put on?
Jonathon: at first, I thought it would be a long USD/CHF position of $1000 units
Jonathon: but in that case, if the quote'd pair would to fall by half, my entire balance would be lost
Jonathon: which isn't 1:1
Jonathon: understand what I'm asking?

Crystal: a moment please

Jonathon: Thank you

Crystal: what you can do is to long 1000 units of USD/CHF
Crystal: the total cost will be 1000 units x 0.91333 = $9133.30

Jonathon: Ok, I understand that part. But hear me out:
Jonathon: I have $1000 USD in my account.
Jonathon: I open a position of 1000 units in USD/CHF
Jonathon: in theory, I'm non-leveraged, since I bought $1000 USD with the proceeds of selling CHF

Crystal: alright
Crystal: yes

Jonathon: however, should the USD/CHF fall far over the coming months, let's say to 0.40 (which means the CHF went up in value and now $1 USD buys less of it)
Jonathon: My total loss on the position would be greater than the account value
Jonathon: You can plug the numbers into your own Profit Calculator to see what I mean
Jonathon: http://fxtrade.oanda.com/analysis/profit-calculator/
Jonathon: what's why I'm kinda confused
Jonathon: what starts off as 1:1 leverage becomes way more than that

Crystal: firstly your account will not go into a negative position

Jonathon: (Yeah, I get that, the account would be margin called before hand)

Crystal: you will receive a margin close out once your net asset value falls to 50% of your margin used
Crystal: yes

Jonathon: I'm just trying to illustrate the problem I'm working out and where my confusion comes from

Crystal: so in your scenario
Crystal: yes i do understand

Jonathon: Now, here's the practical side of it:
Jonathon: I'm asking because I'd like to use Oanda to hedge investments in foreign places... thanks to Oanda's ability to open positions down to a single unit of currency (exact and precise amounts.)
Jonathon: If I'm going to hold a foreign denominated bond for years, and want to hedge that currency risk, I need to use a little leverage (yes) but I also need to know how to structure that position.

Crystal: in your scenario

Jonathon: and it seems dollar for dollar (as what I thought) isn't quite 1:1 leverage

Crystal: given 1:1 leverage
Crystal: yes it is not

Jonathon: so I'm at a loss at how to build out a position to do this

Crystal: we go according to unit size and not dollar amount

Jonathon: (and thanks for your help so far, I know this is a bit more intensive of a request than most people would have)
Jonathon:

Crystal: you are most welcome
Crystal: and i do understand where you are coming from
Crystal: i would suggest you use this calculator to calculate the number of units
Crystal: http://fxtrade.oanda.com/analysis/cu...its-calculator
Crystal: this might help you build the position
Crystal: but as long as you have sufficient balance to buffer, your position will be safe

Jonathon: Ok, using this tool, if I enter my account is in USD, and the currency pair is USD/CHF (as per the example) and the leverage is 1:1, and I have full margin available (assuming no other positions are open)... then it tells me that I want a unit size equal to the account size... this is the same problem I mentioned before since that size would be wiped out if the CHF doubled (USD/CHF were to fall by half)
Jonathon: *sadface*

Crystal: yes

Jonathon: For instance, if I moved my account balance to an account based in CHF.. that would also be a non-leveraged position with CHF exposure... but in that case, if CHF were to fall in value by half (USD/CHF raises to twice it's current quoted rate) my account wouldn't be lost and it would still hold some value converting the balance back to USD
Jonathon: so how would I emulate that exposure in a position on a currency pair?
Jonathon: because it seems that opening a USD/CHF position within a USD account would lose a lot more value once the currency pair moves a significant distance from the open price
Jonathon: mm.. still there?

Crystal: Yes
Crystal: there is alot to digest

Jonathon: I will wait, I don't mind

Crystal: how else can i help you?

Jonathon: I just want to understand how to do this properly

Crystal: I will suggest that we will revert back to your via emai;
Crystal: email
Crystal: as we are facing high chat volumes now

Jonathon: Ok... perhaps I could call in about this during business hours on Monday?
Jonathon: would phone support be able to assist with this?

Crystal: i would recommend that I will revert back to you via email

Jonathon: ok
Jonathon: I will await your email
Jonathon: thank you
Jonathon:

To clear up all issues here and very valid ones by all means ,

i would like to point out the leverage of 1:1 i.e. no leverage is applicable only when the account is in the denominator currency of the pair .

Thus if the account would have been in CHF the leverage would have been 1:1 .

In case of the USD acct its 1:2 .

Thus 5000 pips loss on usd acct would be leverage of 1:2 and thus complete wipe out.
and 5000 pips loss on chf acct would be 1:1 and loss of half capital .

In other words DENOMINATOR CURRENCY IS USED IN CALCULATION OF LEVERAGE.

I hope this solves the issue.

To add further ,

the true leverage would only and only be calculated when trading pairs with the denominator base account and round up value of pair is in the ratio of 1:1 which doesnt apply to any pair holding as true leverage and all are rounded up to nearby value hence making majors in the round up relative leverage of 1:1.

Since eur/usd = 1.25 and not 1:1

aud/usd = 1:06 which is relatively closer to 1:1 . Thus relative leverage and not true leverage.

Thus larger trading houses and funds have offices in all the majorly traded currency countries and have accounts in relative currencies so as to avoid this confusion and use relative leverage of 1:1 basing on the denominator currency.

I mentioned a few posts ago that should the account have been in CHF, the loss would be $5k as expected.


But that's not quite the problem, we are trying to figure out the proper exposure for 1:1 leverage when the account is in USD. Remember, our example had the trade opened at parity (a quote of $1 for USD/CHF.) Since it opened at parity, in theory the leverage of 1:1...

But on a USD account, going long on USD/CHF... if USD/CHF dropped by 5000 pips, we'd see a -$10k loss, BUT if USD/CHF went up by 5000 pips, we'd only see a gain of $3333.33...

I'm just trying to wrap my head around how the leverage shifts as the quote changes.. and that relationship of change.. tiz all..


Or maybe (as I mentioned before) my cotton head from being sick this weekend is preventing me from seeing the obvious. *shrugs*