A standard forex account has specific lots and pip units. A lot is the minimum quantity of a security that may be traded while a pip is the smallest amount by which a currency quote can change. Typically, one lot is worth $100,000, and a pip unit is stated in the amount of $0.0001 for U.S.-dollar-related currency pairs. This is the most common pip unit, and it is used for almost all currency pairs.
Pip value is the effect that a one-pip change has on a dollar amount. It is important to note that the pip value does not vary based on the amount of leverage used. Rather the amount of leverage you have affects the pip value. Most brokers offer traders a 100:1 leverage, which means for every $100,000 transaction, the broker will require you to have $1,000 in your account.
For the U..S dollar, when it comes to pip value, 100 pips equals 1 cent, and 10,000 pips equals $1. An exception to this rule is the Japanese yen. The yen's value is so low that each pip is not worth a ten-thousandth of a unit but, rather, each pip is 1% of a yen.
Key Takeaways
- In currency or forex trading, an account has lots and pip units.
- Lots are the smallest amount of the security that can be traded and pips are the smallest amount a currency quote can change.
- Pip value is a measure that reflects how a one-pip change impacts a dollar amount and leverage is the amount of money you have available as a borrower.
- The more leveraged you are, the more risk you are facing; but on the flip side, the more leveraged you are, the greater the opportunity to profit.
Calculating Pips and Leverage
As an example, with a standard lot size of $100,000, pip value is $10 ($100,000 x 0.0001). If your account contains $10,000 and you have a leverage of 150:1, then you will have $1.5 million ($10,000 x 150) or 15 lots ($1,500,000/$100,000) that you can use for investing.
Leverage is the amount of money you can spend as a result of borrowing investment capital. Basically, the more leveraged you are, the riskier your position—a decrease of a few pips could mean losing all of the money in your account. For example, it would be extremely risky to use the entire $1.5 million that you have available because each pip is worth $150 and you could clean out your account just by losing 67 pips ($10,000/150).
When trading a currency against another, the value of the pip is the quoted price, not the base price. For a EUR/USD position, for example, the pip value is in USD (0.0001 USD). However, for USD/EUR, the pip value is 0.0001 EUR. If the conversion rate from Euros to Dollars is 1.45, then a Euro pip equals 0.000145 dollars.
Most forex calculations are displayed in pips. Therefore, to determine your gains or losses, you must convert your pips to your currency. In the USD example, when a trade closes, multiplying the pip difference by the number of traded units will give you the total pip difference between the opening and close of the trade. If the quoted price is USD, the pips are expressed in USD. If the USD is the base currency, convert the pip value to USD.
The Bottom Line
Increasing your leverage increases the volatility of your position because small changes in pip value will result in larger fluctuations in your account value. Although there is a large downside risk to having high leverage, there is also a large upside gain—if you were to make 67 pips instead, your account value would double, and you would rake in 100% returns in one day.
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