To understand how much can be made on a given trade, a trader needs to calculate how much a pip will be worth for a given currency pair. Calculating the final value that a change in pips will be worth depends on the size of currency lots being traded.
Currencies are customarily traded in standard lots, mini lots and micro lots. Standard lots are the largest trading blocs, measured in 100,000 units of a given currency. A standard lot of British pounds, for example, would be £100,000. A mini-lot is equal to 10,000 units of a currency, so one mini-lot of euros would be €10,000. A micro lot is equal to 1,000 units of a currency, so one micro-lot of USD would be US$1,000.
What Is PIP Value?
A percentage-in-point, or pip, is the smallest increment in which the price of a forex currency pair can move. Typically, forex pairs are priced out to four decimal places, making most pips worth 0.0001.
Pip value is the amount of money assigned to each incremental move in price. It's a function of applied leverage and position size―as a position's size is increased, pip value is also increased. For instance, the pip value of a EUR/USD standard lot is far greater than that of a EUR/USD micro lot. Although higher pip values can boost a trade's profitability, they also enhance risk exposure.
How Is PIP Value Calculated?
To calculate the value of the individual pip, divide one pip (or 0.0001) by the exchange rate in effect. In the example of the currency pair USD/CHF, if the exchange rate is 1.0451 francs per dollar, then the value of one pip is 0.0001/1.0451 = 0.000095684. The dollar value of the trade can then be determined by multiplying the value of one pip times the lot size traded.
Examples of Calculating PIPs
Here are some examples of the different lot sizes:
- If it is a standard lot of 100,000, then the value of a movement of one pip will result in an amount of 0.000095684 x 100,000 = US$9.57
- For a mini lot of 10,000, the value of the movement of on pip will result in an amount of 0.000095684 x 10,000 = US$0.96
- For a micro lot of 1,000, the value of the movement of one pip will result in an amount of 0.000095684 x 1,000 = US$0.09
Trading in the Japanese currency, the yen, will be slightly different, as the pip for the yen is quoted to two decimal points rather than four.
For the currency pair USD/JPY, if the exchange rate is 65.00 yen per dollar, then the value of one pip is 0.01/65.00 = 0.0001538. Here's how that would continue to break down:
- For a standard lot of 100,000, the movement of one pip will result in an amount of 0.0001538 x 100,000 = US$15.38.
- The calculation for a mini lot of 10,000 would result in amount of an amount of 0.0001538 x 10,000 = US$1.54
- The calculation for a micro lot would result in amount of 0.0001538 x 1,000 = US$0.15.
How To Use PIP Values In Forex Trading?
Understanding how to use pip values is a key aspect of managing applied leverage in the live forex market. It's important to remember that leverage magnifies both risk and reward. Pip value is an accurate barometer of this relationship as it represents applied leverage and risk exposure in real-time.
Before taking a forex trade, calculating pip value is an essential task. After pip value is derived, the impact of negative price action on the trading account is easily measured. It's then possible to determine a trade's affordability relative to adopted risk and money management parameters. By following this progression, you can identify an ideal stop loss location, customise position size, or forego the trade altogether.
In volatile forex conditions, dramatic pricing fluctuations can place immediate stress on highly-leveraged positions. Monitoring pip value is a great way of addressing the trading account's health and avoiding premature liquidations and margin calls.
Using A PIP Calculator
The forex market is a dynamic atmosphere that provides a vast array of opportunities to participants. Accordingly, it's helpful to be able to simultaneously calculate pip values for a variety of FX pairs.
To streamline your trading process, check out the FXCM Pip Calculator. It features automated functionality and takes the mental gymnastics out of determining pip values.
Margins And Leverage
Pip movements can generate even more return or even more losses if a trader has access to leverage. Leverage is a double-edged sword as it can significantly increase losses as well as profits. Leverage is a when a trader multiplies the amount traded by taking a short-term funding allowance from the brokerage. This is done when the trader opens a margin account by making a small good faith security deposit against possible losses.
Some brokerages will allow leverage of up to 50 to 1 with a margin deposit equal to 20% of the position taken. Thus, with a deposit of as little as US$250, an investor can trade up to US$100,000. A ten pip move that loses or yields US$50 on a given contract could then lose or generate ten times as much using leverage.
Leveraged trades, however, are subject to additional risk. If a trade generates a loss that is greater than the investor has in their account, then the trader can incur a negative (debit) balance (and/or a margin call).
This article was last updated on 3 May 2021.
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