Forex Basics 2 - What is pips and lots
A lot is a number of currency units. One standard lot, equal to 100,000 units of base currencies / your account currency. This means that if you want to trade EUR / USD, you need $ 100,000. There are two other well-known lots sizes. They are mini lots (equal to 10,000) and micro lots (equal to 1,000 units).
To open a transaction, you will need to decide how much money to invest. The term “lot” is closely related to concepts such as “leverage” and “pip”. Let’s take a closer look at this topic.
The biggest benefit of trading on the foreign exchange market is leverage. As we already said, the standard lot is $ 100,000, but that doesn’t mean you have to invest this huge amount of money yourself. Your broker can help you. The standard leverage is 1: 100. This means that if you want to trade a standard pair of hands, you only need to deposit $ 1,000. Your broker will invest the remaining $ 99,000.
A pip means “Percentage In Point”. It represents the smallest change that a currency pair can make. Generally, a currency pair is calculated with four decimal places. For example, the quote for GBP / USD is 1.3463. However, some pairs have 2 decimal points. For example, the quote for USD / JPY is 109.70. Pips are represented by the last decimal of the price / quote.
If the EUR / USD changes from 1.0800 to 1.0805, it will change by 5 points. If the USD / JPY changes from 120.00 to 120.13, it will change by 13 points.
Please note that some forex brokers also calculate the fifth and third digits after the decimal point, respectively. They are called “pipettes” and make spread calculations more flexible.
Using USD / JPY pair as an example. The exchange rate is 110.80.
(0.01 (a pip) /110.80 (exchange rate) x 100,000 (standard lots) = $ 9.03 per pip
When the rate changes to 110.81 or 110.79, you incurs a $9.03 profit or loss;
When the rate changes to 110.82 or 110.78, you incurs a $18.06 profit or loss;
Pips x Leverage x Lots
You already know what leverage, lots and pips are. It’s time to use your knowledge.
Imagine that you trade the EUR / USD pair in 100,000 lots. You deposit $ 1,000. Your leverage is 1: 100. You make a buy trade at 1.15 and the currency pair goes up and closes at 1.1550. This means you earn 50 pips.
Above we have calculated that 1 pips for EUR / USD = 10 USD.
You earn 50 pips, so that means your profit is $ 500.
However, you should keep in mind that your profit will depend on the number of lots, the number of lots you trade, currency pairs and account currency.