An increasing number of people are turning to the foreign currency exchange market in an attempt to generate an income due to the high levels of leverage being offered by brokers and the high liquidity of this market. If you are considering this option, it is important to remember that Forex trading comes with as much potential for loss as it does for gain, which is why it is vital that you learn all you can about the market and about financial trading in general. Thus, you need to start at the beginning and that is with Forex pips.
What Are Forex Pips?
Forex pips are the smallest units of a currency that can be traded, which is usually the fourth decimal point. There is only one exception to this rule and that is with the Japanese Yen, which has only two decimal points. Pip stands for “Percentage In Point”.
Thus, let’s look at the EUR/USD, which is the Euro against the US dollar, where the former is the base currency. A quote for the EUR/USD would be $1.4154, which means that you can buy 1 Euro for $1.4154. One pip is $0.0001 and it might seem a tiny amount, but on a $100,000 position, one pip is worth $10. If we take into account a leverage of 100:1, that means that a trader can open a $100,000 position with as little as $1,000.
Considering that the market can move hundreds of Forex pips a day that can translate into significant gains. Remember, though, that the market can move just as easily against you and you can end up depleting your account in minutes.
Forex pips might represent the smallest unit of a currency and are used to calculate profit and loss. Yet they can have different values, based on lot size. As we showed earlier, on a lot of $100,000, the value of a Forex pip would be equivalent to $10. This is because Forex pips are only worth $0.0001 when only $1 is taken into account. Thus, if you multiply $0.0001 by $100,000 you get to $10 per pip. Thus, for a lot size of $10,000, any Forex pips you make or lose will be worth $1.
The good news is that thanks to leverage, you don’t have to trade with $100,000 for each pip to be worth $10. For example, if the leverage on your account is 100:1, it means that you can open a $100,000 position with only $1,000. However, remember to allow yourself some room for error, which is why it compulsory that you do not commit all of your available funds. Forex trading can be quite risky and you need to take as many measures as you can to mitigate the risks involved.
The value of Forex pips is relatively the same across the board, except when it comes to more exotic currency pairs. However, most brokers will do the calculations for you, including how much profit you have made in cash terms and not just pips. This will free you to spend more time on the important aspects of Forex trading, namely studying charts and enhancing your skills to become a successful trader.