Spot Forex is traditionally traded in lots, also referred to as contracts.
The standard size for a lot is $100,000. In the last few years a mini lot
size has been introduced of $10,000 and this again may change in
the years to come.
As we mentioned on the previous page, currencies are measured in
pips, which is the smallest increment of that currency. To take
advantage of these tiny increments it is desirable to trade large
amounts of a particular currency in order to see any significant profit.
We shall cover leverage later, but for the time being let's assume that
we will be using $100,000 lot size. We will now recalculate some
examples to see how it affects the pip value.
USD/JPY at an exchange rate of 116.73
(.01/116.73) X $100,000 = $8.56 per pip
USD/CHF at an exchange rate of 1.4840
(0.0001/1.4840) X $100,000 = $6.73 per pip
In cases where the US Dollar is not quoted first the formula is slightly
different.
EUR/USD at an exchange rate of 0.9887
(0.0001/ 0.9887) X EUR 100,000 = EUR 10.11 to get back to US
Dollars we add a further step
EUR 10.11 X Exchange rate which looks like EUR 10.11 X 0.9887 =
$9.9957 rounded up will be $10 per pip.
GBP/USD at an exchange rate of 1.5506
(0.0001/1.5506) X GBP 100,000 = GBP 6.44 to get back to US
Dollars we add a further step
GBP 6.44 X Exchange rate which looks like GBP 6.44 X 1.5506 =
$9.9858864 rounded up will be $10 per pip.
As we said earlier your broker might have a different convention for
calculating pip value relative to lot size, but however they do it they
will be able to tell you what the pip value for the currency you are
trading is at that particular time. Remember that as the market moves
so will the pip value depending on what currency you trade.
So now that we know how to calculate pip value lets have a look at
how you work out your profit or loss. Let's assume you want to buy
US Dollars and Sell Japanese Yen. The rate you are quoted is
116.70/116.75 and because you are buying the US Dollar you will be
working on the 116.75, which is the rate at which traders are
prepared to sell.
So you buy 1 lot of $100,000 at 116.75. A few hours later the price
moves to 116.95 and you decide to close your trade. You ask for a
new quote and are quoted 116.95/117.00. As you are now closing
your trade and you initially bought to enter the trade, you now sell in
order to close the trade and you take 116.95 which is the price
traders are prepared to buy at. The difference between 116.75 and
116.95 is .20 or 20 pips. Using our formula from before, we now have
(.01/116.95) X $100,000 = $8.55 per pip X 20 pips =$171
In the case of the EUR/USD you decide to sell the EUR and are
quoted 0.9885/0.9890, you take 0.9885. Now don't get confused
here. Remember you are now selling and you need a buyer. The
buyer is biding 0.9885 and that is what you take. A few hours later the
EUR moves to 0.9805 and you ask for a quote.
You are quoted 0.9805/0.9810 and you take 0.9810. You originally
sold EUR to open the trade and now to close the trade you must buy
back your position. In order to buy back your position you take the
price traders are prepared to sell at which is 0.9810.
The difference between 0.9810 and 0.9885 is 0.0075 or 75 pips.
Using the formula from before, we now have (.0001/0.9810) X EUR
100,000 = EUR10.19: EUR 10.19 X Exchange rate 0.9810
=$9.99($10) so 75 X $10 = $750.
To reiterate what has gone before, when you enter or exit a trade at
some point you are subject to the spread in the bid/offer quote. As a
rule of thumb, when you buy a currency you will use the offer price
and when you sell you will use the bid price.
So when you buy a currency you pay the spread as you enter the
trade but not as you exit and when you sell a currency you pay no
spread when you enter but only when you exit.
