Currency Exchange Rate: Understanding Pips - The Winning Trades (Module 2)
We are now going to the second learning module of our Easy Forex Trading Guide for Beginners. In the previous module, we've talked about the idea of forex and provided you of a sample forex quote.
In this post, we'll provide you with an in-depth understanding of how to read forex quote. You'll also learn a few significant terms you'll often encounter in forex trading.
Let us now continue with the discussion.
As of now, you might not have an idea what the term is. Starting today, you'll be facing this one every time you do forex trading. The Price Interest Point or Pip(s) are what we call those price move within an exchange rate. Analyzing possible future changes in value can help traders do winning entry and edit orders.
To provide you a short example, if EUR/USD moves from 1.2345 to 1.2346, it means USD incline one pip in value. Keep in mind that the pip is the last decimal place within a quotation.
Most pairs have up to four decimal places. There are a few exceptions such as the Japanese yen, which only have two decimal places.
A few brokers do quote currency pairs more than the standard four/two decimal places. They prefer a quotation with five/three decimal places. That last decimal places are called fractional pips/pipettes. Below is a sample graphic for further understanding.
Use of Point of Pips
The value of pips on trade may differ, and it greatly depends on the lot size. In layman's term, the lot is the smallest trade size a trader can place whenever trading in the forex market. We'll explain more about the lot later.
Now, when a trader is positive in pips, he is to generate profit in his trade. However, if it's negative, the trader is to lose in the trade. That's why traders usually look at the pips as reference for a loss or gain.
The single pip impact on the value of a dollar will depend on the number of purchased euros. For instance, pip moved by ten basis points. The pip changes could result in great volatility in the value of the currency.
For example, a trader has a USD/EUR in a quote of 1.2341. If this trader purchases 10,000 euro with US dollars, the amount to be paid is $8,103.07.
How will it be computed?
Keep in mind that it often at $0.0001 in US-dollar currency pairs. Meaning it refers to as 1/100th of 1 percent or 1 basis point. Below is the formula you should remember in order to compute the price of a trade.
([base/quote]x[to purchase quantity]) = N
So, if we are to put our sample scenario on the formula it will be:
([1/1.2341]x[10,000]) = $8,103.07
Determine if the trade is a loss or a profit
The financial value of every pip will depend on three aspects. One, the currency pair to trade. Two, the size of the trade. Three, the exchange rate.
On those aspects, changes even at a single pip may affect the value of the opening positions. For instance, a trader traded a $200,000 with EUR/USD pair. It's close were at 1.2345 upon gaining 20 pips. First, look for the number of the quote currency (the USD) every pip represents. Then multiply the value of trade by 1 pip.
200,000 x 0.0001 = 20 USD each pip
Now, find the total profit or loss by multiplying the number of gaining pip by the value of every pip in EUR.
20/1.2345 = 16.2 EUR
Then finding the overall profit or loss in a trade, multiply the number of pip gained on the value of every pip in the EUR. That to reach the total profit or loss in trade.
(pips gained) x (EUR per pip) = N
20 x 16.2 = $ 324
Lots" in Forex
Moving forward, let's discuss another term often heard in forex trading - the lots. Basically, lots are the number of currency unit a trader is about to buy or sell. There are a variety of sizes for lots. The standard size is 100,000 units of a currency. The mini size is 10,000, the micro size is 1,000, and the nano size is 100 units.
For instance, a trader chooses a standard size lot. That means, he is to purchase 100,00 of the base currency at the same time selling an equal number of units of its counter currency. So if the ask price of EUR/USD is 1.2300, the euros to buy is 100,00, and the dollars sold is 123,000.
The higher the unit size is, the fewer pips are needed in making a profit or having a loss.
Ever heard of the term leverage? In forex trading, leverage is one of the main reasons why people do trade. Leverage allows one to trade without providing the exact full amount from their own capital. To clarify, it enables a trader to go up about 1,000 times more than his own capital/money.
For instance, the currency pair EUR/USD moved 100 pips. From 1.5500 it became 1.5600. One of the reasons why traders do a large amount of trade - in lots.
With leverage, a trader can maximize his potential profit in any price movements. However, it could also maximize loss in trade. If a trader wanted to control $100,00 position, his broker will set a $1,000 aside in his account. This trader's leverage now is 100:1. Meaning, the trader is in control of a $100,000 position with just $1,000. Other leverage can be 50:1, 100:1 or even further.
Now let us move to another forex jargon you should learn - margin. The margin is the deposited $1,00 you need to provide in order to use leverage as explained above. It is a deposit a trader should provide as collateral to be able to hold a position. Remember that the amount of margin required to hold open position will determine by the trade size. In short, the higher the trade size, the higher the margin requirement is.
Now, what if the market goes against the traders plan to profit? That resulting in an insufficient amount of margin. In such cases, the "margin call" comes, wherein the broker closes the trader's position and limits losses. With margin call, the trader's account will not turn to a negative balance.
Stop Order/Limit Order
Now, if a trader has insufficient time in monitoring the price of a currency pair he is trading, he can ask to place a stop order or a limit order to his broker.
But first, let's discuss what market order is. The market order is the best available price of a currency pair to buy or to sell. For instance, the bid for EUR/USD is at 1.2345, and the ask is at 1.2435. If the trader chooses to purchase, it is to sell to him with the ask price 1.2435.
There are two kinds of stop loss order. One, the stop entry order. Two, the stop loss order. Stop entry order includes placing an order to purchase above the market or to sell below the market within a specific price. Meanwhile, the stop loss order is the process used to avoid further loss whenever the price moves against your profiting plan. This order will stay affected until the position is canceled or liquidated.
The limit order is in either the buy below the market or the sell above the market within a specific price. What's great about limit order is that the trader can put a sell limit order and if it reaches that specific price, the trading platform will automatically integrate a sell order. This order is often used if the trader believes that the price will soon reverse upon hitting the price he chooses.
Below are some other kinds of orders in the forex market:
This order will stay active until the trader decides to cancel it. It will be the trader's responsibility to remember that he has an order scheduled.
Its name states itself. This order will be active until the end of the trading trade.
The combination of entry and/or stop loss order. If one is executed, the other will be canceled.
This is the opposite of OCO. It includes putting orders of the parent order is triggered.
Moving on, as cited in chapter one (Exchange Rate - forex quotes), spread it the difference in the bidding price and the asking price. Keep in mind that spread always represented as pips.
The amount of every trade transaction is called the spread. The amount will depend from broker to broker. Spread is the simplest way of brokers to compensate in every transaction a trader executes.
For instance, the EUR/USD price is 1.2222. The trader chooses to purchase that pair, but the asking price isn't exactly 1.2222. Most likely, it is at 1.2223, which is the price to pay.
Even if the spread isn't that much, a larger trade will quickly add up in the small spread.
Hope you've learned a low in this 2nd module. On the next module, you'll learn the different types of currency pairs and which will be the most appropriate pair for you.
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