Pips and Lots explained
Getting started on forex trading, there are important terms in Forex. These are sure words you would come across in your journey as a forex trader. Some of the words are Pips and Lots. In trading, understanding the concept behind pips and lots is of utmost importance. This guide explicitly explains what forex lots and pips mean.
What is Pip?
Pip is an acronym for “percentage in point” or “price interest point.” A pip is the smallest price move that an exchange rate can make based on forex market convention.
Taking a score as a case study. A score is a group of 20 elements, depending on the subject in view, could be 20 eggs, 20 cups, 20 pencils, etc. So also, a pip has a standard of one-hundredth of one percent (i.e. 1/100th of 1%), this is also referred to as the fourth decimal place (0.0001). The unit of measurement to express the change in value between two currencies is simply referred to as a “pip.”
Let’s take a look at a cube measuring 6 inches x 6 inches x 6 inches. Understanding what inches mean, you should be able to give me an estimate of the size of the cube. Right? Yeah, so also should every trader be able to have an accurate understanding of what pips mean.
A pip measures the amount of change in the exchange rate for a currency pair and is calculated using the last decimal point. Since most major currency pairs are priced to 4 decimal places, the smallest change is that of the last decimal point which is equivalent to 1/100 of 1%, otherwise referred to as one basis point. Traders often use pips to reference gains or losses.
If a trader says “I made 12 pips on the trade” means that the trader profited by 12 pips. Conversely, if a trader says “I lost 12 pips”, it means he’s at a loss by 12 pips. The actual cash amount this represents depends on the pip value.
For currency pairs displayed to 4 decimal places like EUR/USD, GBPUSD e.t.c. one pip equals 0.0001. Although Yen-based currency pairs are an exception and are displayed to only two decimal places (0.01). A fractional pip is equivalent to 1/10 of a pip, making it possible to view the currency pair with five decimal places (Yen-based quote currency now to 3 decimal places).
In forex markets, currency trading is conducted frequently among the U.S. dollar, the Japanese yen, the Euro, the British pound, and the Canadian dollar. Four major currency pairs are vastly traded and have the highest volume. They are known as the major pairs. These are the EUR/USD, USD/JPY, GBP/USD, and the USD/CHF.
So also, the change in a currency value relative to another is measured in pips, which is a very, small percentage of a unit of currency’s value. A pip measures the amount of change in the exchange rate for a currency pair and is calculated using the last decimal point. Most major currency pairs are priced to 4 decimal places.
The monetary value of each pip depends on three factors:
- The currency pair being traded.
- The size of the trade.
- The exchange rates.
Based on these three factors, the fluctuation of even a single pip can have a significant impact on the value of the open position.
Take a trader who wants to buy the USD/JPY pair as a case study. The trader would be purchasing US dollars and simultaneously selling Japanese Yen dollars i.e. In simple terms, USD/JPY means Buying/Selling. The USD/JPY pair shows traders how many Japanese Yen Dollars are required to buy one US Dollar. Conversely, a trader who intends to sell US dollars would sell the JPY/USD pair, buying Japanese Yen dollars simultaneously. Traders often use the term “pips” to refer to the spread between the bid and ask prices of the currency pair, and to indicate how much gain or loss can be realized from a trade.
The value of a pip is calculated by multiplying the amount of the trade-in lots by one pip in decimal form, and then dividing it by the current exchange rate of the quote currency in your pair.
Let’s solve some examples.
A Trader sold EUR/USD from a price of 1.12300 to 1.12200. How many pips did the trader make as profits?
Subtract 1.12200 from 1.12300
1.12300 – 1.12200 = 0.001
Since 1 pip=0.0001 X pip = 0.001
Multiply 0.001 by 1 and divide by the multiplication of 0.0001 by X
The final answer is 10 which is the number of pips.
A Trader bought USD/CAD from a price of 1.13300 to 1.13600. How many pips did the trader make as profits?
Subtract 1.13300 from 1.13600
1.13600 – 1.13300 = 0.003
Since 1 pip=0.0001
X pip = 0.003
Multiply 0.003 by 1 and divide by the multiplication of 0.0001 by X
The final answer is 30 which is the number of pips.
A Trader sold CHF/JPY from a price of 111.700 to 111.300, How many pips did the trader make as profits?
Subtract 111.300 from 111.700
111.700 – 111.300 = 0.4
Since 1 pip=0.01
X pip = 0.4
Multiply 0.4 by 1 and divide by the multiplication of 0.01 by X
The final answer is 40 which is the number of pips.
What is Lots?
The unit that makes it possible to compare quantities just using the numbers (measured in forex trading) is referred to as LOTS. A “lot” is a standard unit, used for measuring a transaction amount.
Placing orders on your trading platform, you place them in lots! Taking an arm’s length as a case study, it differs with a person, making it not to be widely accepted as a standard measurement.
However, lots are what makes trading standardly measured throughout the world. This is the number of currency units you will buy or sell. It may have prefixes like standard, mini, micro, and nano enabling traders to have a better understanding of the amount traded.
A standard lot is equivalent to 100,000 units of currency. By buying 1 lot of a currency pair, you buy 100,000 units of the base currency (the preceding in the currency pair). e.g. USD in USD/CHF.
If the USD/CHF exchange rate was $6.4000, one standard lot of the base currency (preceding pair i.e. USD) would be equivalent to 640,000 units.
As the word standard denotes- it is used as a measure for comparative evaluations. Hence, it can be used as a comparative measure for other lots variations (mini, micro, nano).
A Mini lot is 10% of a standard lot which is equal to 10,000 units. Hence, when a trader orders 0.1 lots He/She is trading 1 mini lot.
If the USD/CHF exchange rate was $6.4000, one mini lot of the base currency (preceding pair i.e. USD) would be equivalent to 64,000 units.
A micro lot is equal to 1% of a micro lot which is equivalent to 1000 units. Hence, when a trader orders 0.01 lots He/She is trading 1 micro lot.
If the USD/CHF exchange rate was $6.4000, one standard lot of the base currency (preceding pair i.e. USD) would be equivalent to 6,400 units.
Nano lot in Forex is a distinguished prefix based on the choice of the forex broker. This is why it is with a slight variation from other types of lot sizes. Some forex brokers set nano lots to 10 units while others set it to 100 units some may even set it to 1000 units. However, nano lot is not widely used because only a few brokers offer it. However, most brokers use 100 units.
Proper understanding of these four prefixes of lots measurement will help you to account for changes in currency value, no matter how meager.
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