WHAT ARE PIPS AND LOTS?

WHAT ARE PIPS AND LOTS?

WHAT ARE PIPS AND LOTS?, In this article of our forex course we have to do some basic math. You probably have heard the terms "pips" and "lots" if you have already read something about the Forex market. Here we will show you what they are and how they are calculated.

Take the time to digest this information, as it is vital knowledge that every Forex investor must learn and manage. Do not even think about starting to do Forex trading without being able to calculate the value of a pip and without being able to calculate gains and losses.

What is a Pip?

A pip is the least possible change in the value of a currency pair. If for example the EUR / USD pair moves from 1.3150 to 1.3151, that is 1 PIP. A pip is the last decimal in the quote. Through the pips you will calculate the gains and losses.

Since each currency has its own value, it is necessary to calculate the value of a pip for each particular currency.

In pairs where the US dollar (USD) is the base currency, the calculation would be as follows:

Imagine the pair USD / JPY to a value of 119.80 (you will see that for this pair only two decimals are used, while the great majority uses four decimals).

In the case of USD / JPY, 1 pip equals .01

That is to say,

USD / JPY:

119.80

.01 divided by the quotation = pip value.

.01 / 119.80 = 0.0000834

It might look like a very small number, but then we'll see how everything is relative to the lot size.

USD / CHF:

1.5250

.0001 divided by the quotation = pip value.

.0001 / 1.5250 = 0.0000655

USD / CAD:

USD / CAD:

1.4890

.0001 divided by the quotation = pip value.

.0001 / 1.4890 = 0.00006715

In the case where the dollar (USD) is not the base currency, and we want to obtain the dollar value of a pip, an additional step will be required.

USD / JPY:

1.2200

0.0001 divided by the quotation = pip value.

So

USD / JPY:

0.0001 / 1.2200 = EUR 0.00008196

But we want to get the value in dollars, so we do a more calculus

EUR x Quote

So

USD / JPY:

0.00008196 x 1.2200 = 0.00009999

We rounded it to make it 0.0001.

GBP/ USD:

1.7975

.0001 divided by the quotation = pip value.

SO:

0.0001 / 1.7975 = GBP 0.0000556

But we want to get the value in dollars, so we do a more calculus

GBP x Quotation.

SO:

0.0000556 x 1.7975 = 0.0000998

We rounded it to 0.0001.

In the next section we will find out how these numbers that might seem insignificant can have a great impact when investing in Forex.

WHAT IS A LOT?:

Forex is operated in lots. The standard size of a lot is $ 100,000. There are also mini-lots that are $ 10,000. And there are even micro-lots of $ 1,000. As you have already learned, currencies are measured in pips, which are the smallest possible increase. In order to make a profit out of these small increments, we need to trade large amounts of a particular currency to achieve some significant gain or loss.

Assume that we will use a standard lot of $ 100,000. We will do some calculations to see how the value of a pip is affected.

USD / JPY at a rate of 119.90

(.01 / 119.80) x $ 100,000 = $ 8.34 per pip

USD / CHF at a rate of 1.4555

(.0001 / 1.4555) x $ 100,000 = $ 6.87 per pip

In the case when the dollar is first, the formula changes a little.

 

EUR / USD at a rate of 1.1930

(.0001 / 1.1930) X EUR 100,000 = EUR 8.38 x 1.1930 = $ 9.99734 and round it to $ 10 per pip.

 

GBP / USD at a rate of 1.8040

(.0001 / 1.8040) x GBP 100,000 = 5.54 x 1.8040 = 9.99416 and rounded it to $ 10 per pip.

Depending on the online broker with which we work, they may have some different peculiarities when calculating the value of a pip relative to the size of a lot. But in any case, as long as market prices vary, so can the value of a pip vary according to the currency being used.

How do I calculate profits and losses?:

Now that we know how to calculate the value of a pip, let's look at how we would calculate our profits or losses.

Let's put an example where we buy US dollars (USD) and sell Swiss Francs (CHF).

Imagine that the quote is at 1.4525 / 1.4530. As we are buying USD, the ask price is used, which is 1.4530.

We bought 1 lot from $ 100,000 to 1.4530.

A few hours later, the price rose to 1.4550 and it was decided to close the transaction.

The new rate is at 1.4550 / 1.4555. As we are closing the transaction, and initially we made a purchase to start the operation, we need to close the same operation with a sale, with the price of 1.4550.

Using our previous formula, we calculated a gain of (.0001 / 1.4550) x $ 100,000 = $ 6.87 per pip x 20 pips = $ 137.40.

Remember that when you open a position, you are subject to the spread that is the difference between the bid / ask and it is the commission that the brokers receives for executing the transaction ..

When you buy, you will use the ask price, and when you sell, the bid price will be used.

What is Leverage?

We've already talked a little about leverage in the previous article (How do you make money in Forex?) But if you have not seen it yet, you'll probably be wondering how a small investor like you could handle such huge sums of money. Think of your Forex broker as a bank that lends you $ 100,000 to buy currency but only asks you for a deposit of $ 1000 as a guarantee of good faith or endorsement to carry out the transaction. It sounds too good to be true, but this is how leverage is used in the Forex currency market or in some other investment instruments.

The maximum level of leverage available to use depends on the broker you work with and can vary from one investment instrument to another.

Generally online brokers that offer service to retail customers require a very small initial minimum deposit to open a trading account. Once deposited that money, you will be able to perform Forex trading. The broker will also tell you which margin you need to have available in your account as a guarantee for operations

For example, imagine that your broker offers you a leverage of 1: 100. For every $ 1000 you have available in your account, you can open operations for 1 lot of $ 100,000. So if you have $ 5,000, you could manage a $ 500,000 (5 lots) position.

The margin for each lot (margin) can vary greatly from one broker to another. In the example above, the broker requires a margin of 1%. This means that for every $ 100,000 invested, the broker takes a $ 1000 deposit as collateral.

What is a margin call?

In addition to the margin of guarantee necessary to open a position there is also a margin of maintenance to keep your position open. In the event that the money in your trading account falls below the required margin requirements, the broker will proceed to close some of the positions you have open to reposition your balance and account within the margin required. This is a measure to prevent you from taking a negative balance and incurring a debt. These measures to avoid negative balances are executed automatically according to the evolution of your positions, even in a highly volatile and fast environment like the Forex market.

EXAMPLE 1

Suppose you open an account with $ 2000 and buy a lot of EUR / USD with a margin requirement of $ 1000. The usable margin is the money available to open new positions or handle losses. As started with $ 2000, the usable margin is $ 2000. But when you open a lot, which requires a margin of $ 1000, the available margin will now be $ 1000.

If your position goes into losses and those $ 1000 that remain free in your account trading account do not cover the maintenance margin requirements will occur the margin call or margin call.

EXAMPLE 2

Suppose you open a $ 10,000 Forex account. You trade 1 lot of EUR / USD, with a margin requirement of $ 1000. Remember that the available margin can be used to open new positions or to sustain any losses of the current open positions. Before opening the position, you would have $ 10,000 of available margin. Once you open the position, you have $ 9000 of usable margin.

Make sure you understand the difference between usable margin and the margin used.

If the balance of your account falls below the usable margin due to losses, you will have to deposit more money or the broker will close the position to limit the risk both for you and for them. As a result of this you can never lose more than the amount you have deposited.

It is vital to know the requirements with respect to the margin of the online broker that you are going to use and also to feel comfortable with the risk that you are assuming in each operation.

NOTE: This article is not an investment advice. Any references to historical price movements or levels is informational and based on external analysis and we do not warranty that any such movements or levels are likely to reoccur in the future.