What Do Pip Values Tell Me?

Pips are used by Forex traders to

represent the smallest increment changes in price of one currency relative to another.

In our EUR/USD example, a change in value of 1 pip means a potential profit or loss of U.S.

$10. Whether you earn $10 or lose $10 depends on the value of the Euro relative to the

Dollar (or vice versa).

Right now, the Euro is stronger - so, any downward change in the Euro would actually

create a

counterintuitive as that sounds.

The reason Forex traders use pips to calculate profit and loss is because it simplifies the

trade - or, I should say - because

Pips calculations reflect the fact that almost all Forex transactions are undertaken in some

multiple of 10.

We trade in lot sizes of 100,000, 10,000 and 1,000 so that the effects of even the slightest

change in currency values can be seen right away, and capitalized on immediately.

The good news that you don't have to calculate these values yourself. Your broker will do it

for you, and the information will be available in your online account.

calculate profit and loss. Recall, again, that pipsprofit for you in U.S. Dollars. You would profit from 'buying high' and 'selling low', asstandard lot sizes simplify trades.

It is crucial that you understand pips values on the conceptual level, even if you don't

want to do the math yourself.

Concept #4 - Anatomy of a Trade: Bid Price; Ask Price and 'Spread'

Forex quotes include more than just the exchange rate. They also include a

an

They come from entities known as

banks and brokerages that are ready to buy and sell currency at a moment's notice.

If these market makers didn't exist, you would not be able to buy or sell currency at will.

There has to be someone else involved in the transaction.

It is the market maker who sets the

always higher than the

So, let's say that you want to buy Canadian Dollars. The market maker must purchase your

U.S. Dollars with Canadian Dollars, so the transaction will first be expressed in terms of the

exchange rate for the currency pair:

CAD/USD = 1.2

It will cost the market maker $1.20 CAD to purchase $1.00 USD from you. Good so far,

right? Now, let's say you intend to sell $100 USD.

The

However, the market maker can choose to quote a higher price for his base currency. He

can, for example, quote you an

On your end of the transaction, though, you will see this mark-up expressed in CAD as an

ask price of $120.05. In doing so, the market maker profits by requiring you to buy a fraction

more Canadian Dollars. This is done so that he receives a fraction more in U.S. Dollars.

120.05 - 120.00 = 0.05 or $0.0005

This number represents what's known as the

bid price, then, is $120 CAD for $100 USD.ask price of $100.05 USD for $120 CAD.spread.

The concept of the “spread” is important when determining your profit and loss because you

may be subject to it both when entering and exiting a trade. The amount of the spread will

vary based on whether you are the

In the CAD/USD example, you entered the trade as a

technically 'selling' U.S. Dollars in exchange for the Canadian Dollars does not matter here

because the trade began with you responding

If you wanted to enter a trade as a

currency that you already hold.

The general rule of thumb is this:

buyer or the seller.buyer. The fact that you areas a buyer to a market maker's ask price.seller, then you would need to respond to a bid price for



As a buyer, you pay the spread as you enter a trade, but not when you exit.



you exit as a buyer.

As a seller, you do not pay the spread as you enter a trade, but you do pay it when

At this point, you might be thinking to yourself: “It looks like I get hit with a spread no matter

what I do, because I'll inevitably be in the role 'buyer' at some point on every trade.” This is

true, but your profit and loss depends partly on what kind of spread you're subject to during

the transaction.

In our CAD/USD example, where you are a buyer, you are subject to the following spread

on a trade of 100,000 units:

(.0001/1.2) x 100,000 = $8.33 x 5 pips = $41.65

If you close the trade as a seller at CAD/USD = 1.25 (bid price)/1.27 (ask price), you are not

subject to the new spread of $0.0007 (7 pips). You simply close the trade with a sale, and

subtract the spread from your profit.

However, let's say that you already had some Canadian Dollars, and decided to enter the

trade as a seller at 1.27, and then close the trade as a buyer?

You would be subject to the new spread of 7 pips, or $56.

This means you have a potential gain or loss of $14.35 per lot, depending on when you

enter the trade, and whether you have entered as a buyer or seller. It may not seem like

much, but these types of losses and gains accrue with each trade.

As a retail trader, your margins will be small to begin with, and you can't afford to be

careless.

Speaking of margins, you may wonder how you can get involved with Forex when the

average lot size is $100,000. That is a very good question, and it leads into the concept of

margins and leverage.

Concept #5: Margins and Leverage

Every broker will have a minimum deposit you must meet in order to open an account, as

well as minimum account levels required to trade a specific lot size.

The minimums are known as

you to open an account at lowest 'usable margin' possible, while others may require more

as assurance against you falling below the minimum too rapidly.

The good news is that retail brokers typically do not require matching deposits. In other

words, you need not deposit $100,000 in order to trade $100,000.

Instead, your broker will usually 'front' you the money on good faith. For instance, if you're

broker requires you to trade in lot sizes of $100,000, you may be able to open an account

for $1,000.

initial margins or usable margins. Some brokers might allow

It is somewhat like getting a loan you don't have to repay because you get to “play” with

$100,000 that isn't really in your account.

So, let's say you do really well and manage to trade your way from $100,000 to $105, 000:

$105,000 - $100,000 = $5,000

You've now raised your

of six. Remember, if your broker is matching you $100,000 for every $1,000 in your account,real account balance to $6,000 and your usable margin by a factorbid price andask price. Where do these prices come from?forex market makers. These market makers consist ofask price for the currency being sold. The ask price isbid price, which is typically equivalent to the exchange rate.

then your $6,000 account balance gives you $600,000 worth of

market.leverage for trading on the

What Do Pip Values Tell Me?

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