All traders who start to learn about Forex will surely hear the terms such as pip, lot, leverage, etc.
So what are these Forex terms? Are they important? How do they affect the trading process?
This article will answer all of those questions.
What are the terms “Pip” and “Pipette” in Forex?
What is Pip?
A pip is a measure of the movement in value between two currencies.
For example, When GBP/USD increases from 1.2941 to 1.2942, a rise of 0.0001 is called 1 pip.
For different currency pairs, the value of 1 pip can vary. Such as:
+ For currency pairs that do not include JPY (EUR/USD, GBP/USD, etc.), 1 pip is located at the fourth decimal digit in the rate.
For example, when the GBP/USD rate is 1.3002, the number “2” will represent the pip.
+ Regarding currency pairs that include JPY (USD/JPY, EUR/JPY, etc.), 1 pip is located at the second decimal digit in the rate.
For example, when the USD/JPY rate is 105.27, the number “7” will represent the pip.
What is Pipette?
There are platforms that quote currency pairs other than the standard “the 4th or the 2nd”. They take “the 5th or the 3rd” digit after the decimal point. It means that these brokers also quote odd pips. And this odd pip is called a pipette.
For example, When the GBP/USD rate increases from 1.29815 to 1.29816, the rise of 0.00001 is called 1 pipette.
What is Lot? How to calculate the value of 1 pip per 1 unit of a currency pair
What is Lot?
Forex transactions are executed via a unit called “lot”. 1 standard lot is equal to 100,000 base currency units.
+ Buying 1 lot of GBP/USD means buying 100,000 GBP and selling 100,000 USD.
+ Selling 0.5 lot of USD/JPY means selling 50,000 USD and receiving 50,000 JPY.
How to calculate the value of 1 pip per 1 unit of a currency pair
Example 1: EUR/USD = 1.1131 => 1 EUR = 1.1131 USD.
If you buy 1 EUR, when the price goes up by 1 pip (1.1132), you will make a profit of 0.0001 USD.
Therefore, if you buy 1 lot (100,000 EUR) => Gain 0.0001 x 100,000 = 10 USD per 1 pip.
Example 2: USD/JPY = 108.50.
If you buy 1 USD, when the price goes up by 1 pip (108.51), you will make a profit of 0.01 JPY = 0.01/108.50 = 0.000092 USD.
Therefore, if you buy 1 lot (100,000 USD) => Gain 0.000092 x 100,000 = 9.92 USD per 1 pip.
The Pip alone only shows the change in the currency pair rate.
It is only valid when accompanied by the number of units for the currency pair you are trading.
How to calculate profits in Forex
Profit / Loss = Unit of volume x 100,000 x the changed decimal part.
Example 1: Buy 0.5 lot of GBP/USD at 1.3002 => Sell at 1.3022. Price rising by 20 pip is equivalent to a move of 0.0020 USD.
- Profit = 0.5 x 100,000 x 0.0020 = 100 USD.
Example 2: Buy 0.2 lot of EUR/JPY at 120.25 => Sell at 120.40. Price rising by 15 pip is equivalent to a move of 0.15 JPY.
- Profit = 0.2 x 100,000 x 0.15 = 3000 JPY = 3000/108.69 (USD/JPY rate) = 27.6 USD.
What is Leverage? Why do we need to use leverage?
What is Leverage?
Leverage is a loan which the platform offers you. It allows you to execute a transaction with a value many times greater than your trading account. The aim is to gain significant profits from small price movements.
Why do we need to use leverage?
Thanks to leverage, you can trade BIG with A SMALL CAPITAL.
In Forex, the platform will allow you to use many different leverage levels, which can be 1:100, 1:200, 1:500, etc. These levels have different values depending on the regulation of each platform.
So what are 1: 100, 1: 200, 1: 500, etc.?
For example, If you want to place a buy order of 1 lot of GBP/USD, your account balance must have enough 100,000 USD for margin to open the order. However, when you use the 1:1000 leverage, the amount you need to deposit is only 100,000/1000 = 100 USD.
It can be said that leverage is a double-edged sword in Forex. It can help your account grow quickly. On the contrary, it also burns your account instantly if you do not have an effective method of trading and capital management.
In Part 1, there are just a few of the many terms that you need to know when participating in Forex.
Hopefully, the article has provided you with useful information.
Leverage is a powerful “weapon” if you know how to use it. Choose for yourself an effective trading strategy so that your account can grow steadily and stably.
To be continued…