08 What is Forex Pricing – Pips – Lots and Spread
Read on to learn What is Forex Pricing – Pips – Lots and Spread.
In the stock market we buy individual shares, but in the FX markets we trade specific amounts called Lots.
Originally the smallest trade size we could make was 1 Lot. If you are buying 1 lot of the EUR/USD pair, you would be selling x amount of USD to buy 100,000 EURO. This is obviously a fairly large trade and you would need a large trading account to trade this amount (if you are using some sort of decent risk management).
Because most traders start out with relatively small accounts, 50k, 10k, even 1k or less, most brokers now offer smaller lot sizes. This enables these smaller accounts to trade and manage their risk a lot better.
The 4 main Lots sizes that you can now trade are:
- 1. Lot (Standard Lot) = 100,000 units of the base currency
- 2. Mini Lot = 10,000 units of the base currency
- 3. Micro Lot = 1,000 units of the base currency
- 4. Nano Lot = 100 units of the base currency
Note: not all brokers will offer all of these lot sizes. Some may just offer standard and mini lots. So keep this in mind when you are looking at different brokers to work with. Also many brokers that offer Micro or Nano lots trade against you, more on this in the broker section.
PIP is simply used as an easy way to express a price movement in a FOREX spot pair. If you are looking at the EUR/USD pair and the price is 1.1816 and then moved up to 1.1823.
You would not normally describe this increase by saying the pair has increased by .0007 cents, you would simply say it has increased by 7 Pips.
This is a lot easier to say and understand!
So how do we know what a Pip is?
On the USD/JPY a move from 112.43 to 112.48 would be a 5 Pip increase
For all other currency pairs 1 Pip is calculated from the 4th decimal place.
On the EUR/USD a move from 1.1816 to 1.1819 would be a 3 Pip increase.
The main reason the YEN is different is not just to be difficult. It is because they have no dollars, they really just deal in cents.
In the US, like most other countries they have dollars and cents, but in Japan they just have Yen.
So if the US had no dollars and just used cents it would be similar, $1.25 would be 125 US cents.
As the forex markets have developed over the years and technology has increased you will now see most FX pairs quoted to 5 decimal places, or 3 decimal places for the Yen based pairs.
This does NOT affect what a PIP is. This just means we can now easily speak in fractions of a pip. This fraction of a pip is now commonly referred to as a Pipette.
If you bought the EUR/USD at 1.18166 and later sold it at 1.18197 you could say you made a profit of 6.1 pips or 6 1/10 pips or 6 pips and 1 pipette or 61 pipette’s…
Personally I would just say 6.1 pips.
If you bought the USD/JPY at 112.460 and later sold it at 112.494 you could say you made a profit of 3.4 pips or 3 4/10 pips or 3 pips and 4 pipette’s or 34 pipette’s…
Again I would just say 3.4 pips, but all of the above are saying the same thing, so up to you.
What is a pip worth?
Ok so let’s say you did make a 6 pip profit, what does that really mean, how much did you actually make, what is 1 pip actually worth?
To work this out you need to make 1 of the 2 following calculations:
- Account currency is the same as the Quote currency
- Pip Value = (Position Size x 1 pip)
- $1.00 = (10,000 x 0.0001)
- Pip Value = $1.00
- So if your account currency is in USD then you would use this calculation for any pair that has the USD as the Quote currency.
- For example: EUR/USD, AUD/USD, NZD/USD, GBP/USD etc.
- Account currency is NOT the same as the Quote currency you need to add another step.
- Pip Value = (Position Size x 1 pip) / Conversion Pair Price
- $0.72 = (10,000 x 0.0001) / 1.3854
- Pip Value = $0.72
- The Conversion Pair Price is the exchange rate of the quote currency and account currency.
- So if your account currency is in USD then you would use this calculation for any pair that does not have the USD as the Quote currency.
- For example: USD/JPY, EUR/GBP, AUD/JPY, NZD/CHF etc.
- Let’s look at the NZD/CHF pair as an example.
- Say you made 14 pips profit trading 2 mini lots in your USD based account, how much USD did you actually make?
- NZD/CHF = .69771 (Although this is the pair that we want the pip price on, we do not need this figure)
- USD/CHF = .97079
- Our formula is: (Position Size x 1 pip) / Conversion Pair Price = Pip Value
- (20,000 * 0.0001) / .97079 = $2.06
- So if you made 14 pips then you would simply multiply 14 by $2.06 giving you a total profit of $28.84
And if all of this is too tiring or confusing, then simply use the calculators here. They do it all for you : ) – Easy as pie!
We use the calculators, the only reason we added these examples in this course is so that if you have to work it out manually, then you can : )
What is the Spread in Forex?
Most FX brokers do not charge a commission to let you trade with them.
So does that mean these brokers are just really nice people that honestly want you to succeed?
We’ll, not exactly…
What they do, is simply widen the spread and pocket the difference (and hope no one notices). It may sound a little dodgy and I guess it kind of is, but it has been done for so many years now that it is just common practice.
The Spread is simply the difference between the Bid and Ask prices.
The Bid price is the highest price someone is willing to pay for this item…
And the Ask price is the lowest price someone is willing to accept for selling this item…
When you place a simple market order to buy, you will buy at the Lowest Ask price (the lowest price someone is willing to sell the item to you).
And When you place a simple market order to sell, you will sell at the Highest Bid price (the highest price someone is willing to buy the item from you).
Every time we trade pay the Spread!
If you told your broker (or placed a order online) to buy 1 lot of the EUR/USD and then it sell straight away before the price even moved, you would lose money.
Even if the market did not move!
This is because of the spread : (
Right now looking at my chart on my MT4 broker platform I see the following 2 prices for the NZD/USD pair:
- Ask: 0.71052
- Bid: 0.71046
If we subtract the Bid from the Ask we are left with the Spread. In this case it equals: 0.6 pips (Ask 0.71052 – Bid 0.71046 = 0.00006)
On 1 std lot, this would have cost us $6.00 (as you have just learnt from the previous Pip Value section)
So back to our good old broker, not all of this spread is their profit, there is always a spread as we discussed in the Market Structure section earlier on..
If there was no spread at all, then it would mean that all current buyers and all sellers wanted to transact at the same price and in the online trading world, this would happen in just a few seconds and then there would be no market, no buyers or sellers left (except for new players continually coming into the market)…
But let’s say the actual interbank spread is .4 Pips, your broker can simply widen this and offer it to you at 1.1 Pips. This way every time you trade your broker will make 0.7 pips from you, this is their commission (even though they like to say they don’t charge a commission…)
When you open and close a position, you pay the spread!
Note: When looking at a chart, they are normally displayed using the bid price, but regardless of what you see on the chart you always buy at the ask and sell at the bid…
Looking for a good automated trading solution?
See our top Forex trading robots here. They have proven results are professional programmed, simple to use and most offer free trials.
Or if you have a strategy or idea you would like programed check out FastMT4Coding. These guys can help with all your MT4 Indicators and Expert Advisor requirements.