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CALCULATING THE TRUE VALUE OF A PIP |
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Calculating the true value of a pip 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 lesson 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 or loss. We shall cover leverage later but for the time being let's assume we will be using $100,000 lot size. We will now recalculate some examples to see how it effects the pip value. Learn the Secret of Trading - Click here Examples USD/JPY at an exchange rate of 120.50 (.01/120.50) X $100,000 = $8.29 per pip USD/CHF at an exchange rate of 1.2479 (0.0001/1.2479) X $100,000 = $8.01 per pip In cases where the US Dollar is not quoted first the formula is slightly different. EUR/USD at an exchange rate of 1.2875 (0.0001/ 1.2875) X EUR 100,000 = EUR 7.76 to get back to US Dollars we add a further step EUR 7.76 X Exchange rate which looks like EUR 7.76 X 1.2875 = $9.991 rounded up will be $10 per pip. GBP/USD at an exchange rate of 1.9689 (0.0001/1.9689) X GBP 100,000 = GBP 5.07 to get back to US Dollars we add a further step GBP 5.07 X Exchange rate which looks like GBP 5.07 X 1.9689 = $9.9823 rounded up will be $10 per pip. As we said earlier your broker may 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. Learn the Secret of Trading - Click here So now 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 120.69/120.73 because you are buying the US you will be working on the 120.69, the rate at which traders are prepared to sell. So you buy 1 lot of $100,000 at 120.69. A few hours later the price moves to 120.89 and you decide to close your trade. You ask for a new quote and are quoted 120.89/120.93 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 120.89 the price traders are prepared to buy at. The difference between 120.69 and 120.89 is .20 or 20 pips. Using our formula from before, we now have (.01/120.89) X $100,000 = $8.27 per pip X 20 pips =$165.40 In the case of the EUR/USD you decide to sell the EUR and are quoted 1.2875/1.2878 you take 1.2875. Now don't get confused here. Remember you are now selling and you need a buyer. The buyer is biding 1.2875 and that is what you take. A few hours later the EUR moves to 1.2797 and you ask for a quote. You are quoted 1.2797/1.2800 and you take 1.2800 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 1.2800 The difference between 1.2875 and 1.2800 is 0.0075 or 75 pips. Using the formula from before, we now have (.0001/1.2800) X EUR 100,000 = EUR7.81: EUR 7.81 X Exchange rate 1.2800 =$9.9968 ($10) so 75 X $10 = $750.00 Learn the Secret of Trading - Click here To reiterate what has gone before, when you enter or exit a trade at some point your 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
When you buy a currency you pay the spread as you enter Lets move on to Lesson 5 Leverage
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