What are Pips and Lots?
24.08.2020
As the title says, let;s jump straight into it...
What is a Pip?
A pip is the smallest possible change in the value of a currency pair. If, for example, the EUR / USD pair is moving from 1.3150 to 1.3151, that is 1 PIP. A pip is also the last decimal of the quote.
Through the pips the losses and gains will be calculated.
As each coin has its own value, it is necessary to calculate the value of a pip for each particular coin. In pairs where the US dollar (USD) is the base currency, the calculation would be as follows: Let's imagine the USD / JPY pair at a value of 119.80 (you will see that for this pair only two decimal places are used, while the vast majority use four decimal places).
In the case of USD / JPY, 1 pip equals 0.01... That is to say...
- USD / JPY:
- 119.80
- .01 divided by the market value = pip.
- .01 / 119.80 = 0.0000834
- It might seem like a very small number, but we'll see later how everything is relative to batch size.
- USD / CHF:
- 1.5250
- .0001 divided by the price = pip value.
- .0001 / 1.5250 = 0.0000655
- USD / CAD:
- 1.4890
- .0001 divided by the price = pip value.
- .0001 / 1.4890 = 0.00006715
In the case when the dollar (USD) is not the base currency, and we want to obtain the dollar value of a pip, an additional step will be required.
- EUR / USD:
- 1.2200
- .0001 divided by the price = pip value.
- So
- .0001 / 1.2200 = EUR 0.00008196
- But we want to get the dollar value, so we do one more calculation
- EUR x Quote
- So
- 0.00008196 x 1.2200 = 0.00009999
- We round it to 0.0001.
- GBP / USD:
- 1,7975
- .0001 divided by the price = pip value.
- So
- .0001 / 1.7975 = GBP 0.0000556
- But we want to get the dollar value, so we do one more calculation
- GBP x Quote.
- So
- .0000556 x 1.7975 = 0.0000998
- We round it to 0.0001.
In the next section we will find out how these seemingly insignificant numbers can have a big impact when trading Forex.
What is a lots?
Forex is operated in batches. The standard lot size is $ 100,000. There are also mini lots that cost $ 10,000. And there are even $ 1,000 micro lots. As you have already learned, currencies are measured in pips, which is the smallest possible increment. To make any profit from these small raises, we need to trade large amounts of a particular currency for a significant profit or loss
Suppose we are going to use a standard lot of $ 100,000. We will do some calculations to see how the value of a pip is affected.
- USD / JPY at a rate of 119.90
- (.01 / 119.80) x $ 100,000 = $ 8.34 per pip
- USD / CHF at a rate of 1.4555
- (.0001 / 1.4555) x $ 100,000 = $ 6.87 per pip
- In the case where the dollar is the first, the formula changes a bit.
- EUR / USD at a rate of 1.1930
- (.0001 / 1.1930) X EUR 100,000 = EUR 8.38 x 1.1930 = $ 9.99734 and we round it to $ 10 per pip.
- GBP / USD at a rate of 1.8040
- (.0001 / 1.8040) x GBP 100,000 = 5.54 x 1.8040 = 9.99416 and we round it to $ 10 per pip.
Depending on the online broker we work with, they may have some different peculiarities when calculating the value of a pip relative to the size of a lot. But in any case, as long as market prices vary, the value of a pip can thus vary according to the currency that is being used.
How do I calculate profit and loss?
Now that we know how to calculate the value of a pip, let's see how we would calculate our profit or loss. Let's take an example where we buy US dollars (USD) and sell Swiss Francs (CHF). Let's imagine that the price is at 1.4525 / 1.4530. As we are buying USD, the ask price is used, which is 1.4530. We buy 1 lot for $ 100,000 at 1.4530. A few hours later, the price rose to 1.4550 and it was decided to close the deal. The new rate is at 1.4550 / 1.4555. As we are closing the transaction, and initially we made a purchase to start the operation, we need to close the same operation with a sale, with the price of 1.4550. The difference between 1.4530 and 1.4550 is .0020 or 20 pips. Using our formula above, we calculate a profit of (.0001 / 1.4550) x $ 100,000 = $ 6.87 per pip x 20 pips = $ 137.40.
Remember that when a position is opened, you are subject to the spread, which is the difference between the bid / ask and is the commission that the brokers receives for executing the operation.
When buying, the ask price will be used, and when selling the bid price will be used.
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