Understanding pip value is crucial for forex traders, as it helps in calculating potential profits or losses and managing risk effectively. This lesson will guide you through the basic concepts of pips and pipettes, how to calculate pip value for different currency pairs, and the significance of pip value in trading.
What is a pip value, and how is it calculated?
To answer the question, you’ll need this information: the lot size you’re trading, the quote currency, and your account currency.
Allow me to explain.
The Lot Size
As you are probably aware, there are many lot sizes in the forex market, such as standard lot, mini lot, and so on.
1 standard lot is comparable to a hundred thousand units and is worth 10 dollars each pip.
1 mini lot equals 10.000 units and is valued at 1 dollar per pip, while
1 micro lot equals 1.000 units and is worth 10 cents per pip or 0.1 dollars per pip.
One thing to remember is that 10 mini lots equal 1 standard lot, as 10.000 units multiplied by ten equals 100.000 units.
And 10 micro lots equal to 1 mini lot, as 1.000 units multiplied by ten equals 10.000 units.
However, this calculation is only valid when the Quote Currency is in US Dollars.
Quote Currency
So, what is Quote Currency?
In direct and indirect currency pairs, the Quote Currency serves as the second currency and is utilized to value the Base Currency. For example, for GBPUSD, the base currency is the pound sterling (GBP), whereas the quote currency is the dollar (USD).
USDJPY The base currency is the USD, while the quote currency is the JPY.
GBPJPY The base currency is the GBP, while the quote currency is the JPY.
In that case, what if the quote currency isn’t the US dollar? If you’re trading a currency that isn’t the US dollar, then the calculation will follow the quote currency instead of the US dollar. When you’re trading, for example, the EURAUD, then the calculation will look like this:
1 standard lot is 10 Australian Dollars for 1 pip
1 mini lot is 1 Australian Dollar for 1 pip
1 micro lot is 0.1 Australian Dollars for 1 pip
The same calculation if we trade in GBPJPY,
1 standard lot is 10 Japanese Yen for 1 pip
1 mini lot is 1 Japanese Yen for 1 pip
1 micro lot is 0.1 Japanese Yen for 1 pip.
If we calculate using the lot size, we simply multiply it by the lot size we are using. For example, if we enter two standard lots in EURAUD, the pip value will be 20 AUD per 1 pip.
If we enter 2,7 standard lots in GBPJPY, we will receive a pip value of 27 JPY for 1 pip.
But then, how do you use this in real-life trades?
To put it into practice, you’ll need to calculate using the currency of your account.
Account Currency
When we open an account with a broker, we have to deposit our money in one type of currency for each account. You can open an account in USD, AUD, or another currency, depending on your brokerage. When you try to open an account with VT Markets, for example, you can only open an account with these currencies.
In this lesson, let’s try out the USD and CAD accounts.
Open a $1,000 USD account. The calculation will be simpler because most significant currency pairs, such as EURUSD, GBPUSD, and AUDUSD, use the USD as the Quote Currency.
The calculation for these pairs is as simple as adding the total value to your balance.
For example, if you earn 20 pips on a 1 standard lot of EURUSD, you earn a total profit of 20 pips multiplied by the 10USD pip value, for a total of 200USD. If you enter a 2 standard lot, you will receive 20 pips multiplied by ten dollars, then multiplied by 2 lots, resulting in a total of 400 dollars.
To add this profit to your balance, simply multiply your initial amount of 1,000 USD by 400 USD, resulting in a balance of 1,400 USD. This will be different the next time you open an account using CAD as the account currency.
Assume you have a 1,000CAD balance in your account. If we use the same profit as in the sample above, 400USD, then the profit cannot be added immediately to the CAD balance, simply because the currencies are different. To accomplish this, you must first convert the profit from USD to CAD. You must be aware of the exchange rate at the time of position closure.
Consider the following example: the exchange rate between USD and CAD is 1,25, which equals 1USD to 1,25CAD. Thus, 400USD multiplied by 1.25 equals 500CAD. Then you can add this to your balance: your initial balance of 1,000 CAD will be increased by 500 CAD (converted from 400USD), bringing your total to 1,500 CAD. It may appear hard, but there is no need to be concerned because all trading platforms nowadays provide an auto-calculating tool. This implies that your earnings will be calculated automatically using the currency associated with your account.
Conclusion For Pip Value and Calculation:
Understanding pip value and how to calculate it is crucial for successful forex trading. Knowing the pip value for your trades helps you manage your risk and make informed trading decisions. By mastering these calculations, you can better anticipate potential profits or losses and refine your trading strategies.
FAQ
Q: What is a pip in forex trading?
A: A pip is the smallest price movement in the forex market, usually representing a one-digit change in the fourth decimal place of a currency pair.
Q: How do you calculate pip value?
A: Pip value is calculated using the formula: Pip Value= Pip Value = (0.0001 / Exchange Rate) × Lot Size
Q: Why is pip value important?
A: Pip value is crucial for calculating potential profits or losses and managing risk in forex trading.
Q: What is the difference between a pip and a pipette?
A: A pip is typically a one-digit move in the fourth decimal place, while a pipette is one-tenth of a pip, allowing for more precise price measurements.
Q: Can VT Markets help with understanding pip value?
A: Yes, VT Markets offers comprehensive tools and resources to help traders understand and calculate pip value effectively.
Ready to master pip value calculations? Open a demo account with VT Markets today and practice trading with virtual funds. Join VT Markets and enhance your forex trading skills!
