In forex trading, PIPs and LOTs are two critical concepts to understand. A PIP is the smallest change unit in a currency pair, and a LOT is a measurement used to standardise forex contracts. When trading forex, you must understand how these two concepts work to make the most informed decisions possible. You can start forex trading through Saxo Bank’s website.
A PIP is a minor unit of change that a currency pair can make. For most pairs, a PIP is 0.0001. So, if the EUR/USD exchange rate goes from 1.2500 to 1.2501, that would be a one-PIP move.
Traders use PIPs to calculate profits and losses in forex trading. For example, if a trader buys one standard lot (100,000 units) of EUR/USD at 1.2500 and then sells it at 1.2501, they would have made $10 (100,000 x 0.0001).
A LOT is a measurement used to standardise forex contracts; a standard lot equals 100,000 units of the base currency. So, in the EUR/USD example above, one standard lot would be equivalent to 100,000 Euros.
There are also mini lots and micro lots, which are smaller versions of a standard lot. A mini lot equals 10,000 units of the base currency, while a micro lot equals 1,000 units. Mini and micro lots are often used by new or inexperienced traders, as they allow for more flexibility and minor losses if the trade goes against them.
How can traders use PIPs in forex trading?
Determine your account currency
The first step is determining whether your trading account is denominated currency. It will usually be the same as your domestic currency, but it may be different if you are an international trader. For example, if you are from the United States and have a USD-denominated trading account, any profits or losses you make in EUR/USD will be calculated in USD.
Calculate the value of a PIP
Once you know what currency your account is denominated in, you can calculate the value of a PIP for that particular currency pair. Divide the PIP value (0.0001 for most pairs) by the exchange rate.
For example, if the EUR/USD exchange rate is 1.2500 and your account is denominated in USD, the PIP value will be:
0.0001 / 1.2500 = 0.00008
It means that for every one-PIP move in EUR/USD, the value of your position will change by $0.00008.
Determine your position size
The next step is determining how many units of the currency pair you want to buy or sell, which is known as your position size. Position size is usually expressed in lots – a standard lot equals 100,000 units, a mini lot equals 10,000 units, and a micro lot equals 1,000 units.
For instance, if you want to buy 100,000 units of EUR/USD, that would be equivalent to one standard lot. If you only want to buy 10,000 units, that would equal a mini lot. And if you only want to buy 1,000 units, that would be a micro lot.
Calculate your potential profit or loss
When you know the value of a PIP and your position size, you can calculate your potential profit or loss for the trade. Multiply the PIP value by your position size and the number of PIPs the currency pair has moved in your favour.
For example, if EUR/USD moves from 1.2500 to 1.2510 and you are long (bought) one standard lot (100,000 units), your profit would be:
(0.0001 x 100,000) x 10 PIPs = $10
If the currency pair had moved against you by 10 PIPs, your loss would be the same – $10.
PIP values are also expressed in pips per point (PPP), simply the value of a PIP divided by the current price of the currency pair. For example, if EUR/USD is trading at 1.2500 and the value of a PIP is 0.00008, then the PPP will be:
0.00008 / 1.2500 = 0.000064
For every point that EUR/USD moves in your favour, you will make a profit of $0.000064. If the currency pair moves in opposition to your prediction by one point, you will lose $0.000064.