To become a successful trader, it is crucial to get complete knowledge of the terminology in the forex market. This chapter is dedicated to make you understand Forex Pips, Lots, Margin, and Leverage. Every terminology has an example to clear doubts.
The value of the currency pair and trade size is quoted in the form of pips and lots.
What is a pip?
A pip is a unit that determines a change in the value of one currency relative to another. As the currency pairs are traded to 4 decimal places, a change of 0.0001 is called a “pip”. Suppose, a currency pair EUR/USD moves from 1.0861 to 1.0862, the difference is 0.0001 (1.0862-1.0861) which means the value is moved up one pip.
Very Important: Most forex trading is done to 4 and 2 decimal places, but you may come across a broker that goes to 3 and 5 decimal places. These are called fractional pips and a change in the value is measured in “pipette”. Let’s take an example:
If this value moves down to 1.08611, then you can say that the value moves down one pipette (1.08612-1.08611).
Some currencies go out to two decimal places. One such currency is Japanese Yen pair.
As a beginner trader, you should concentrate on pips rather than the actual dollar value or value in some other base currency you are trading in. However, you should have knowledge about how to calculate the value of a pip for a particular currency pair. Let’s understand this with an example:
Suppose, the value of 1 EUR = 1.0847 USD which should be written in the forex terms as EUR/USD 1.0847 or to make the calculations easy, we can write it as 1 EUR/1.0847 USD.
Now, the value of one pip is calculated by multiplying the exchange rate ratio with the value change in the counter currency. So, the value of 1 pip for EUR/USD should be calculated as:
[1 EUR/1.0847 USD] X [0.0001 USD] = 0.0000921913 USD per unit
Here is the simpler version:
[1/1.0847] X [0.0001] = 0.0000921913 USD per unit
According to this example, if we trade 10000 units of EUR/USD then a change in one pip will change the position value by 0.921913 USD (10000 units X 0.0000921913) which is approx. 0.92 USD. I have mentioned approx. here because the value of exchange rate is variable and so is the value of a pip.
What is a lot?
As you have already understood that a change in pip is a minuscule percentage and that is why to get good profit you have to trade a lot of units. Forex trading is done in “lots” and one standard lot has 100000. There are also nano, micro and mini lot sizes with 100, 1000 and 10000 units each. So, the smallest amount you can buy or sell is 100 which is rarely done by any trader. Mostly the forex market traders prefer trading in a standard lot.