You probably already heard people speaking about pips and lots, but do you know everything about these terms? How are they calculated? If not, this section is for you. To trade on the Forex, it is essential to handle these concepts. They will help you to calculate your profits and losses and to set correctly your stop loss.
What’s a pip ?
A pip is the smallest unit of variation of an exchange rate (cf quotes). As you can see, currency pairs are quoted in 4 decimals for most of them. A pip is the last decimal. If EUR/USD rose from 1.4018 to 1.4019, this means that the euro has appraised of one pip against the dollar.
A pip is equal to 0.0001. However on USD/JPY, the pip does not have the same value because the cotation is only in two decimal. So, a pip is equal to 0.01. You got it, the value of a pip depends on the currency pair because each currency has its own value. It allows on each transaction, depending on the currency you deal with, to calculate your profit or loss.
Now that you know what a pip is, we can proceed to its calculation. The value of a pip is equal to : the smallest unit of a currency pair / exchange rate
Get back to our previous examples:
For USD/JPY, the smallest unit of measurement is 0.01 because the cotation is done in 2 decimals.
Assuming that USD/JPY is priced at 90.68 and that we are trading with one unit of 100 000 USD
Value of a pip(JPY) = 100 000*0.01= 1000 JPY
To know the value of this pip in USD, we need to make the following calculation:
Value of a pip(USD) = 1000/90.68 = 11.03 USD
For EUR/USD, the smallest unit of measurement is 0.0001 because the cotation is done in 4 decimals.
Assuming that EUR / USD is priced at 1.4018 and that we are trading with one unit of 100 000 EUR
Value of a pip(USD) = 100 000*0.0001= 10 USD
To know the value of this pip in EUR, we need to make the following calculation:
Value of a pip(EUR) = 10/1.4018 = 7.13 EUR
The value of a pip depends also on the cotation of the currency.
But keep cool; you will never do this calculation. Your broker will do it for you but it seemed me important to show the method of calculation.
What’s a lot ?
On the Forex, we trade with lots most of the time. This is the minimum unit of investment on the market. The standard size of a lot is 100 000E. But, depending on the type of account you will open with your broker, smaller lots exist. There are lots of 10 000E and 1000E. The latter is often the minimum size to trade on the Forex with all brokers. This sounds tremendous to you but do not panic. Indeed, lots are linked with pips which as you know now are a unit of measurement very small. It is therefore necessary to trade with important quantities to make significant gains and losses. Lots will actually serve to increase the value of a pip.
Assuming the following example. You decide to trade with a lot of 10 000E. EUR/USD is priced at 1.4018.
Value of a pip = (0.0001/1.4018) * 10 000 = 0.7133 EUR
This means that if EUR/USD takes or loses one pip, you win or lose depending on your position 0.7133 EUR. The value of a pip is moving all the times because it depends on the price. However, once you entered on the market, the amount of your profit or losses will be based on the value of a pip at the time of your entry on the market. So you can calculate your profits or losses.
Case study
The EUR / USD is priced at 1.4018 / 1.4020. You anticipate a fall of the dollar. So you buy EUR.
– Your entry price is at 1.4020 because it is the price at which traders are ready to sell euros.
– You use a lot of 10 000E
The value of a pip is equal to: (0.0001/1.4020) * 10000 = 7.132E
A week later, you exit your position. EUR / USD is priced at this time: 1.4050/1.4052
You exit your trade at 1.4050, because it is the price at which traders are ready to buy EUR.
So, your profit is 30 pips, overall of 30 USD or 21.35 EUR (30 USD / 1.4050(price at the time of your sell))