Before now, spot forex trading takes place in a definite amount known as “lots.” They mean the number of currency units a trader will sell or buy.
100,000 units of currency are the standard size for a lot. Today, we have a nano, macro, and mini lot sizes ranging in 100, 1000, and 10,000 units respectively.
Remember that the change in the value of currency as it relate to another is measured in ‘pips’—a very tiny percentage representing a currency’s value unit.
You can take advantage of this minute change in value by trading a huge amount of a specific currency to record any significant gain or loss.
For example, we are to make use of a standard lot size (100,000 units), let’s now do some recalculations and see the effects it has on the pip value.
1. USD/JPY exchanging at the rate of 119.80: {.01/119.80} x 100,000 =$8.34 for each pip.
2. USD/CHF with a rate exchanging at1.4555: {.0001/1.4555} x 100,0000 =$6.87 for each pip.
In situations where the US dollar is not quoted at the beginning, the formula will be different a bit.
1. GBP/USD exchanging at 1.8040 {.0001/1.8040} x 100,000 = 5.54 x 1.80×40 = 9.99416 when summed up will amount to $10 perp pip.
2. EUR/USD exchanging at 1.1930: {.0001/1.1930} x 100,000 = 8.83 x 1.1930 = $9.99734 summed up will become $10 per pip.
Note that your broker may have another different rule for calculating the value of pips in relating to the lot size. However, no matter the formula they may use, you will be able to learn from them the exact pip value of the particular currency you are trading at that point in time.
As changes take place in the market, so will the pip value moves, depending on the currency you’re trading.
What for Christ’s sake is leverage?
Sometimes you might wonder aloud how on earth a low-level investor can conveniently trade such tremendous amount of money.
Well, start seeing your broker as a bank that typically empowers you with $100,000 upfront to buy currencies.
All that the bank requires from you is to provide a good-faith deposit of $1000, which the bank will be holding for you, but not necessarily keeping it.
It sounds too good to be true, right? Well, this is how forex trading is making use of leverage.
The amount or volume of leverage you will use will largely depend on your broker and also what you feel will be comfortable for you.
Traditionally, your broker will demand a trading deposit (account margin or initial margin), which after depositing it with the broker, you will become empowered to trade. Furthermore, the broker will also let you know how much it will need per position (a lot) traded.
Here is an example, assuming the permitted leverage is 001:1 or just 1% of the position demanded, and you planned to trade a $100,000 worth position, whereas, you have just $5000 in your account.
Don’t worry, since your broker will put aside $1000 as the margin or down payment, which will then allow you to ‘borrow the rest’.
Yes, any gain or losses will be added or deducted to the remaining balance left in your account.
The minimum margin or security for each lot varies from one broker to the other.
From the above-given example, a one percent margin was demanded by the broker. It, therefore, means that, for every $100,000 traded, a deposit of $1000 on the position is needed by the broker.
But wait a minute: How am I supposed to calculate profit and loss?
Thank goodness that you’re now good with calculating pips value and leverage. Now, let’s delve into how you can calculate your gains and losses.
Let’s start with an example of buying US dollars and selling Japanese Yen.
1. 14525/1.4530 is the rate you quoted. Seeing that you are purchasing US dollars, what you will be working on is the ASK price of “1.450”, which is the rate traders are prepared to sell.
2. In that case, you purchase 100,000 units (as 1 standard lot) at the rate of 1.4530.
3. After some few hours, the price went up to 1.4550 and concluded it’s time to close your deal.
4. The new quote for USD/JPY is now 1.4550/1.4555. Being that you initially purchased to open the trade, it is now a MUST that you sell to close the deal, which means taking the ‘BID’ price (1.4550). That’s the price at which traders are set to buy at.
5. The actual difference between the value of 1.4530 and 1.4550 is 2 pips or 0020.
6. Employing our previous formula (0001/1.4550) x 100,000 will equal $6.87 for each pip x 20 pips which equal $137.40.
What about Bid-Asked Spread?
Remember that whenever you enter and exit a trade, you become subject to the spread that is there in the bid/ask quote.
When you purchase a currency, you will make use of the offer or Ask price.
The BID price is what you will use whenever you sell.
Our next lesson will focus on the latest forex lingos you have learned. So stay tuned.
