Spot forex that is traded in a certain size is called a lot or the number of currency units that you will buy or sell.
The standard size for lots is 100,000 units, there are also mini, micro, and nano sizes with 10,000, 1,000 and 100 units respectively.
| LOT | NUMBER OF UNITS |
|---|---|
| Standard | 100,000 |
| Mini | 10,000 |
| Micro | 1,000 |
| Nano | 100 |
As is well known, the change in the value of one currency relative to another is measured in "pips" which is a very small percentage of a unit of currency value.
To take advantage of this change in value, you need a large amount of funds to make a significant profit or loss.
Let's assume a lot size of 100,000 units (standard) and recalculate with some examples to see how it affects the pip value.
USD/JPY at 119.80: (.01 / 119.80) x 100,000 = $8.34 per pip
USD / CHF at 1.4555 exchange rate: (.0001 / 1.4555) x 100,000 = $6.87 per pip
In the case of an exchange rate not quoted in US dollars, the formula is slightly different.
EUR/USD at 1.1930 exchange rate: (.0001 / 1.1930) X 100,000 = 8.38 x 1.1930 = $9.99734 rounded up to $10 per pip
GBP / USD at 1.8040 exchange rate: (.0001 / 1.8040) x 100,000 = 5.54 x 1.8040 = 9.99416 rounded up to $10 per pip.
Your broker may have a different convention for calculating pip value relative to lot size but either way, they will tell you what the pip value is for the currency being traded at any given time.
As the market moves, the pip value will also depend on the type of currency being traded at the time.
What is leverage (leverage) ?
You may ask how a small investor can make such a large amount of transactions.
Assume that a broker is like a bank that gives you a $100,000 loan to buy currency.
Then you are asked to deposit $1,000 as collateral and will be held but not required to keep it.
Sounds so good to be true? That's how leverage works.
The amount of leverage used depends on the broker.
Usually the broker will ask for a deposit, which is also known as "account margin" or "initial margin." After depositing your money you can start trading. The broker will also determine how much is needed per position (lot) traded.
For example, if the allowable leverage is 100:1 (or 1% of the required position), and you want to trade a position worth $100,000, but only have $5,000 in margin.
It doesn't matter because your broker will set aside $1,000 as a down payment, or "margin," and the rest will be "loaned out."
Of course, any loss or gain will be deducted or added to the remaining cash balance in your account.
The minimum security for each lot will vary by broker.
In the example above, the broker requires a margin of 1%. This means that for every $100,000 transaction, the broker wants $1,000 as a deposit on the position.
How to calculate profit and loss?
After knowing how to calculate pip value and leverage, the next thing is how to calculate your profit and loss.
"Let's buy US dollars and sell Swiss Francs".
The rate is 1.4525 / 1.4530. Since you are buying US dollars, you get the "ASK" price at 1.4530, which is the price the trader is ready to sell.
So you buy 1 standard lot (100,000 units) at 1.4530.
A few hours later the price has moved to 1.4550 and you decide to close the position.
The new rate for USD/CHF is 1.4550/1.4555. Since you originally bought to open a position, you now have to sell to close the position so you have to take the "BID" price at 1.4550 i.e. the price the trader is ready to buy.
The difference between 1.4530 and 1.4550 is .0020 or 20 pips.
Using the previous formula, we now have (.0001/1.4550) x 100,000 = $6.87 per pip x 20 pips = $137.40
Bid/Ask Spreads
Remember! When entering or exiting a position, you are subject to a bid or ask spread.
When buying currency, you will use the ASK quote or price.
When selling currency, you will use the BID price.
Next, we'll show you a summary of the previously learned forex languages!
Tags
forex