pips and lots in Forex trading

What is a pip?

A pip is defined as the minimum possible change in the value of a currency pair. In this case the number of pips or points measures the difference between the entry price and exit price in any Forex trading. For example if the GBP / USD moves from 1.6225 to 1.6250, that is a rise of 25 pips. You can define a pip as the last decimal in the price. It is through the pips that are calculated gains or losses in one trade. As each currency has its own value, it is necessary to calculate the value of a pip for each currency in particular.

For example, in pairs where the U.S. dollar (USD) is the base currency, such as the USD/JPY, the calculation of the pip value would be:

If we have that the value of the USD/JPY is 90.80 (it must be noted that for this pair we use only two decimal places while other currency pairs use up to four).

- For this currency pair, 1 pip is equivalent to 0.01, which means that if the currency pair value is 90.80, the pip value would be given as follows:

 Pip value = 0.01 / quote = 0.01 / 90.80 = 0.0001101

It might seem that the value is almost nil, but the reality is that this is related to the lot size and the leverage as shown below:

What is a lot?

When we trade in the Forex market, this is done through lots. First we have the standard size lots with a value of $100,000. Depending on the type of account and the money we have available in that account, we can also using using mini lots of  $10,000 or even microlots of $1000.

As explained above, the price movements of currencies are measured in pips, which are the smallest increase possible. To benefit from these small increments, we must trade using large amounts of a particular currency pair in order to obtain a significant gain, but in this way we can also can suffer heavy losses. Lots in Forex are defined in relation to the amount of money on each transaction. Depending on the amount of each lot, the classification is divided into the following types of lots:
  • Standard Lot: These are lots that consist of an amount of 100 000 units of the base currency in any pair. In this case the amount that must invest the trader depends on the leverage used. For example if the leverage is 1:100, to perform an operation with one lot the trader must risk 1000 units of the base currency. So if we negotiate in the EUR/USD with a lot with a leverage of 1:100, we have to risk 1000 Euros of our money. The lots are used in standard accounts. 
  • Mini Lot: On the other hand, a minilot consists of 10000 units of the base currency. In this case if we trade  with a minilot using a leverage of 1:100 that means that we are risking $100 of our account  while the broker "lend" us the rest. 
  • Micro Lot: A microlot actually represents  0.01 of a lot, ie one hundredth of a standard lot. If we trade in microlots with a leverage of 1:100, that means that we are risking at least $10 in each trade. With each microlot we trade with 1000 units of the base currency of the pair.

How to calculate the benefit based on the pip and the lot?

The pip

Suppose that we open a long position in the GBP/USD at a price of 1.5500 and we obtain a  profit of +80 pips (1.5580 is the final price). If in that case the trade had been a short position the gain would have been of -80 pips, therefore the trade would have caused losses. If you look at the quoted price of this pair, you can see at a glance that the minimum variation in the price is 0.0001, which is one pip, so we get that the difference of1.5580 (trade exit) -1.5500 (trade entry) = 0.0080, which give us an amount of 80 pips as profit. 

Conversely, if we perform a trade on a currency pair with a quote of two decimal places, as the USD/JPY, the minimum change of value will be of 0.01, which would be a pip in that pair. In any case, the pip value will be the minimum differential between the price at which the trade is performed. If we use the previous example for the GBP/USD, the pip value is: 

 -GBP/USD: 0.0001/1.5500 = 0.00006451

But if we have a quote of 91.30 for the currency pair USD / JPY, the value of each pip is the following:

 -USDJPY: 0.01/91.30 = 0.0001090

The lot

If you want to get the equivalent of money gained or lost with the pips obtained by a trade first of all you must know the volume of the operation, ie the number of lots that have been negotiated during the buy/sell of the currency pair. Thus for example a standard lot is equivalent to 100 000 units of base currency, a minilot is equivalent to 10 000 units of base currency and a micro lot is equal to 1 000 units. 

If we want to calculate the monetary benefit we can use the following example to understand the procedure:

Suppose that we obtained a profit of +50 pips on a trade with a minilot in the GBP/USD. In this case the transaction was a buy at a price of 1.5020 which was closed at 1.5070. The transaction was the purchase of pounds which were sold at the end of the trade. The minimum increment of one pip has a value of 0.0001 which means that when we closed the position at 1.5070 the profit for each pip is the following:

Earnings per pip = (0.0001/1.5070) x 10 000 (lot size) = 0.6636

Due to the fact that in this example we have bought and sold pounds, the result is expressed precisely in this currency but as brokers accounts generally are in U.S. dollars we need to apply another calculation to convert that value to U.S. dollars/pip as shown below:

0.6636 GBP/pip x 1.5070 USD/GBP = 1.0000 USD/pip

In this way, the trader made ​​a profit of 1 dollar for every pip gained during the transaction. In other words, the trader gets $1 per pip when the trade has a volume of 1 minilot . If a similar calculation is made with lots and microlots, for the first ones we can obtain a profit of $10 per pip and for the second ones an earning of $ 0.1 per pip. Therefore if we had entered the market with a lot in the previous example the gain would have been $500

The calculations presented above can be used to calculate the pip value and the profits regardless of the base currency of the currency pair in which the trades are performed. Now for those who do not know much about the Forex market is important to understand that if an investor trades in this market through an online broker then these calculations are not necessary. In this case, these calculations are done automatically in the trading platform, however it is necessary to understand all the details shown on the platform so that the investor knows what is happening.   

General descriptions of the concepts of pips and lots in Forex trading, which are basic to understand how trades are made in this financial market.

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