Pips n Profits

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What is a Pip?

A "pip" is the smallest increment in any currency pair. In the picture of the bid/ask quote below the space between the 2.0404 bid and the 2.0408 ask is 4 pips. The last decimal at the end of each quote is the pip:

So if you enter a long position on GBP/USD at 2.0400 and it moves to 2.0450 by the time you close your position you have made a 50 pip profit. If you enter a long position, again at 2.0450, and close at 2.0570 you have made 120 pips profit. Pay attention now, because this one is important. If you enter a short position at 2.0400 and the price moves up to 2.0450 you lose 50 pips. Remember, short means you want the rate to go down.

When you go long you want the price to go up. When you go short you want it to go down. The units the prices goes up and down in is pips. Since a pip is the last decimal at the end of each quote for GBP/USD a single pips is 0.0001. Keep this in mind as you will need to use this soon.

Pop quiz time. Below are five different sets of quotes showing trades. Look at these trades and calculate how many pips were made, or lost, on each trade. When you have your answer hover your mouse over the empty red boxes below, and the answer will magically appear. Don’t hold your mouse over the empty box for too long, this is very powerful Ninja magic and it shouldn’t be played with!

Trade 1:
Entry = Long GBP/JPY at 151.50″
Exit = Close GBP/JPY at 151.87
Profit/loss =

Trade 2:
Entry = Long on GBP/USD at 1.6077
Exit = Close GBP/USD at 1.6007
Profit/Loss =

Trade 3:
Entry = Short on EUR/USD at 1.3891
Exit = Close EUR/USD at 1.3291
Profit/Loss =

Trade 4:
Entry = Long on EUR/JPY at 130.90
Exit = Close EUR/JPY at 131.23
Profit/Loss =

Trade 5:
Entry = Long on USD/CAD at 1.1659
Exit = Close USD/CAD at 1.0659
Profit/Loss =

So now you should know what a pip is. The question you should be asking now is “how much money is each pip worth?”

How Much is a Pip Worth?

The value of a pip changes depending on the pair you trade. Calculating the value of a pip is not vital to your success, as a trader, since your broker will automatically calculate the value for you. However, since you want to trade you might as well know a thing or two about what you’re trading.

If you’ve been paying attention you know what a pip is. For GBP/USD a single pip is 0.0001.

So if you enter a long position on GBP/USD at 2.0400 and it moves to 2.0450, by the time you close your position, you have made a 50 pip profit.

Every pip GBP/USD moves up or down from 2.0400 is 0.0001. So in the example above, GBP/USD moved 50 pips or 0.0050.

Calculating the current value of a pip is easy. Here is the simple formula:

1 pip / exchange rate = value per pip

Lets take a look at a few examples.

USD/CHF:

Even though that is a tiny amount of money when you learn about lots next you will see how $0.00009250 can become lots of money.

USD/JPY: USD/CHF:

In the next two examples, because the base currency is not USD, using the same equation as above we get the value of a pip in the base currency. So for GBP/USD the pip value will be shown in GBP not USD.

Since most traders trade USD you may want to have the pip value in USD. On any pair, with USD as the quote currency, to get the pip value in USD you simply multiply the pip value by the exchange rate:

pip value x exchange rate = pip value in USD

GBP/USD:

This is rounded up to 0.0001 USD

EUR/USD:

This is rounded up to 0.00001 USD

You will find that all pairs with USD as the quote currency have a pip value of roughly $0.00001 USD.

The next (and thankfully the last) example shows how to calculate the value of a pip, in USD, for pairs that do not have USD as either the base or quote pair.

GBP/JPY:

This time because the quote currency is JPY, multiplying by the exchange rate will give you the pip value in JPY. So to get this to USD you simply take the GBP/USD rate and multiply the pip value by it.

How boring was that? As is said above it is not vital to know this stuff. However, if you’re going to trade Forex, you might as well know how it all works. Next thing you need to learn is Lots and how they change a measly pip worth $0.00009250 to a pip worth $9.25!

Trading Lots

When you enter a trade (go long on GBP/USD) you enter with lots. The more money you want to make per pip, the more lots you trade.

The standard lot size in Forex is 100,000 units ($100,000) and there are also mini lots that are 10,000 units ($10,000). On a mini account, every time you take a trade you are placing $10,000 into the market. Chances are you cannot afford to trade $10,000 at a time that is why your broker is nice enough to give you leverage, which will be explained next.

Previously, you learned how to calculate a pip. The pip value you calculated is based on a single unit. So for every unit entered into the market on a GBP/USD trade when the trade moves 1 pip in your direction you earn 0.00009998 USD. With a mini lot you have 10,000 units in the market so with each pip you will be earning.

pip value x mini lot (10,000) = profit per pip

GBP/USD:

A pair with USD as the base currency.

USD/CHF:

If you’re trading a standard lot you simply multiply how much 1 pip is worth for 1 unit by 100,000 as opposed to 10,000.

pip value x standard lot (100,000) = profit per pip

GBP/USD:

A pair with USD as the base currency.

USD/CHF:

So lots are basically the amount of units entered into the market on a trade. It takes 1 USD to enter 1 unit into the market. The minimum you can enter on a mini account is 10,000 units (10,000 USD) and on a standard account 100,000 units (100,000 USD). However, with the magic of leverage you do not need to enter 10,000 USD of your money into the market to take a trade.

What is Leverage?

Leverage allows you to trade 10, 20, 30 or more units for every single unit you have. So if you have a mini account with $1,000 (1,000 units) and you enter $100 (100 units) of that account into the market you can hold a $10,000 (a 10,000 unit) position. In this case, you would have 100:1 leverage. For every $1 you put into the market your broker puts in $99 to make it $100.

The important thing to remember about leverage is that it does not affect the value of a lot. You know that a mini-lot is 10,000 units of currency and a standard lot is 100,000 units. The value of these never changes no matter what your leverage is. If you have 400:1 leverage a mini-lot is still roughly $1 a pip. If you have 100:1 leverage that same mini-lot is still roughly $1 per pip.

Leverage does not affect the value of a lot but has an effect on the number of lots you can have in the market, based on the capital in your account.

The reason they call it leverage is because it is much like trying to lift a very heavy object. Some objects are just too heavy to lift. However, with the right leverage it’s easy. A seesaw is a perfect example. A normal sized newbie Ninja might find it tough to lift a strong pro ninja. However, if both Ninjas got on a seesaw the leverage provided by the seesaw would make it easy!

If you have 100:1 market leverage then you will not be able to lift as heavy an object as you would if you had 400:1 market leverage. So the higher the leverage the more of your capital you can risk at one time, in comparison to a lower leverage.

If two traders have the same amount of capital, let’s say $10,000 USD, and one has 100:1 leverage and the other has 400:1 leverage, the trader with 400:1 leverage will be able to risk more of his $10,000 at one time than the trader with 100:1 leverage. The trader with 400:1 leverage is required to have less in their account to cover their position.

Let’s use some round numbers in order to better understand this concept. Again, take two traders with $10,000 USD in their accounts. Trader 1 takes a long position at 100:1 leverage on currency pair X/Y and buys 1 mini lot (10,000 units). Trader 2 takes the same long position at 400:1 leverage on currency pair X/Y and buys 1 mini lot (10,000 units). Since Trader 1 has 100:1 leverage then he is required to have 100/1 or 1% of the position in his account. So for Trader 1 he will need to have at least $100 in his account which is 1% of 10,000 (1 mini lot). Since Trader 2 has 400:1 leverage then he is required to have 400/1 or 0.25% of the position in his account. For Trader 2 he will need to have at least $25 in his account which is 0.25% of 10,000 (1 mini lot).

Another way to look at it is from the reverse perspective. Trader 1 with 100:1 leverage cannot buy as many lots with his $10,000 in capital as Trader 2 can with 400:1 leverage and the same amount of capital.

Another example: If you have $1000 capital leverage at 100:1 will allow you to control a maximum of 100,000 units of currency. With that same $1000 capital with leverage at 400:1 will allow you to control a maximum of 400,000 units of currency. Therefore, with a leverage of 100:1 you control less, thus requiring more money in your account.

Please note that the above numbers are examples and rounded off to illustrate what leverage is, and how it is basically determined.

In the end though, you are the one that determines the degree of your leverage. Your broker can only determine the maximum leverage allowed. If you choose to use the maximum that is up to you.

What’s a Margin Call and Should I be Afraid of one?

No you shouldn’t be afraid! A true Fx Ninja has NO FEAR!

A margin call is what happens when you have no money left in your account. To protect you from losing more money than you have your broker closes out your positions. This means you can never lose more money than you have in your account.

Before learning what a margin call is you need to know the definitions of two terms.

Used Margin: The amount of money in your account that is currently used in open trades. If you have $6,000 capital in an account and you have $1,000 in an open trade then your used margin is $1,000. If you have $3,000 capital in an account and you currently have $600 in an open trade your used margin is $600.

Usable Margin: The amount of money in your account minus any open trades. We will continue from the same examples used above. If you have $6,000 capital in an account and you have $1,000 in an open trade your usable margin is $5,000. If you have a $3,000 capital in an account and you currently have $600 in an open trade your usable margin is $2,400.

When your usable margin reaches $0 your broker will automatically margin call you. With good money management this should never happen but newbies can slip up.

Below are a few examples of margin calls:

Tom opens a standard Forex account with $4,000 and 100:1 leverage. This means that on each trade Tom must enter a minimum of 100,000 units ($100,000). With 100:1 leverage Tom must enter $1,000 of his own money to each trade.

Tom analyzes GBP/USD and decides that the pair is going up. He opens a long position with 2 standard lots on GBP/USD. This means Tom is trading $2,000.

Disaster strikes GBP/USD goes down instead of up. Tom curses himself for taking a long but he keeps the position open. If Tom keeps the position open and it moves too far against him he will get a margin call.

Before Tom opens his position he has $4,000 in usable margin. After opening a position with 2 standard lots ($2,000) his used margin became $2,000 and his usable margin became $2,000. If GBP/USD drops by too many pips and Toms useable margin reaches $0 his broker will close out his trade. This protects Tom from losing more money than he has in his account.

Another example:

Mary opens a mini Forex account with $1,000 at 100:1 leverage. She analyzes EUR/USD and decides to go short. Mary enters 7 mini lots ($700) short on EUR/USD. Before entering the positions, Mary’s usable margin was $1,000. Now that she is in the trade her usable margin is $300.

Again disaster strikes and Mary’s trade goes against her. If Mary’s usable Margin reaches $0 her trade is automatically closed, so she cannot lose more money that she has in the account.

Margin calls are easily avoided if you trade sensibly. However, this is more advanced stuff that you will learn later, Apprentice Ninja.

It is very important that you check what the margin polices are with your broker. Margin policies can differ from broker to broker so if you plan to open an account remember to ask.

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