In the previous article, you learned about the order book and the price terminology of forex trading. In this article, let’s dive into pips, lots, and how to calculate pip value for your position. Lets understand what’s pips in forex trading.
What are Pips in Forex?
A pip is a change in a currency by 0.0001
When you look at currencies like EUR/USD, trading at 1.08723, it’s not just 1 dollar and 8 cents. We go even more precise because currencies don’t change by big amounts. They often move just a few cents or even less. Sometimes, they stick within a 1 cent range for months. So, you’re trading these tiny movements, and we look at several decimal points to capture them.
Imagine USD/CAD is trading at 1.33915. If it goes up to 1.33925, it moves by 1 pip. If it drops from 1.33915 to 1.33815, it moves down by 10 pips. So, to calculate pip, focus on the 4th decimal place.
Here’s another example: NZD/USD is trading at 0.66857, and it goes up to 0.66877. In this case, it went up by 2 pips.
Now, we’ve become even more precise and we introduced something new called a pipette, which is a change in currency by 0.00001, meaning we’re now looking at 5 decimal points. For instance, if NZD/USD moves from 0.66857 to 0.66858, it has moved by 1 pipette.
But most of the time, around 99%, we’ll be talking about pips. I mentioned pipettes just to give you some extra info.
Also, a point is the smallest change in a currency. For most currencies, this smallest change is a pipette.
What are Lots?
A lot is a standard measure of units when you are trading currencies.
A “lot” is like a standard unit. When you buy 1 lot of a pair, you buy 100,000 units of the base currency. So, for example, if you’re looking at USD/CAD and you want to buy that currency, it means you want to buy $100,000 worth of CAD, but you want to pay in USD. If it’s EUR/USD, buying 1 lot means you want to buy €100,000 worth of USD, but you’ll pay in EUR.
We always talk about lots in terms of base currencies.
- Standard Lot = 100,000 units (of base currency)
- Mini Lot = 10,000 units
- Micro Lot = 1000 units
A mini lot is about 0.1 of a standard lot, and a micro lot is about 0.01 of a standard lot. We mostly stick to standard lots, just like with pips, but some brokers let you use these smaller lots. Just remember, 1 standard lot equals 100,000 base units.
You might be wondering, “$100,000 for just one trade? That’s a lot of money! How can I manage that?” Well, you’re correct. It is a big amount, but don’t worry. Your broker is going to lend you some money to trade with, and that’s what we call leverage. We’ll dive into that in the next article.
How to Calculate Pip Value?
So, we’ve covered what pips are and what a lot is. Now, the next thing you need to learn is pip value. Pip value is made up of pips and lots. That’s why we talked about pips and lots earlier.
Calculating pip value is figuring out how much money you’ll make in dollars for each currency’s pip movement.
So, how much am I winning or losing for every pip it moves up or down?
For example, let’s say you have USD/CAD, which is trading at 1.35251. Now, how much would it cost you to get 1 lot of this? We know that 1 lot here is going to be $100,000 of the base currency, which is USD. You multiply that by 1.35251, and it’s going to give you $135,251 CAD. That’s the contract value. That’s how much it’s going to cost you in CAD to get this 1 lot.
Contract Value for one lot: 100,000 USD * 1.35251 = 135251 CAD
Now, the pip value is the profit you’ll make for each one pip movement. If USD/CAD were trading at 1.35251, we want to know what would happen to our position if this price moves to 1.35261, which is a 1 pip movement.
Let’s see, what would be the contract value if the price went up by 1 pip let’s calculate it below,
If the price goes up to 1.35261
Then Contract Value = Size of the contract * Exchange rate
Then Contract Value = 100000USD * 1.35261 = 135261 CAD
In this scenario, if the currency goes up by one pip, how much money would we have made? Well, we’d have made the difference between the price we sold the contract for and the price we bought it for 135261 – 135251 = 10 CAD. So, we would make 10 CAD for every 1 pip of movement.
Now, if you want to figure out how much you made in the base currency, which is USD, all you have to do is divide 10 by the exchange rate, which in this case is 1.35251. So, 10 divided by 1.35251 equals 7.39 USD.
Now, when we talk about pip value, it is calculated in quote currency, but if you want to know in base currency, you can do that.
The value of the pip depends on how many lots you’re trading. In this example, we calculated it for 1 lot. But imagine you didn’t, and you bought 0.1 lot. Well, in that case, your pip value would have been 10 times less, so 1 CAD. If your lot size is 0.01, then the pip value will be 0.1 CAD. So, the pip value depends on the lots you are trading.
For instance, let’s consider USD/CAD. If you’re trading 1 lot, you make 10 CAD per pip. Say the price moves from 1.33408 to 1.33628, a difference of 22 pips. So, you can calculate that 22 pips multiplied by 10 CAD per pip equals 220 CAD. That’s how much you’d make if it moved from 1.33408 to 1.33628. With this knowledge, you can calculate potential profits or losses and make other important calculations. This is the essence of pip value.
There is a simple formula to calculate the pip value:
Pip Value = Lots * 10
For example, if you’re trading 1.2 lots of EURUSD, then the pip value will be 1.2 multiplied by 10, which equals 12 USD. So, you’ll make or lose 12 USD for every pip move.
Conclusion
Now that you’ve learned what a pip is, what lots are, and how to calculate your pip value using both, you can figure out how much you’d make or lose per pip movement. In the next article, we’ll learn how we can afford to trade these big amounts by understanding leverage. See you there!
