- Forex Basics
- Japanese Candlesticks
- What Are Japanese Candlesticks?
- Bodies, Wicks and Shadows
- The Doji Candlestick Pattern
- Candlestick Engulfing Pattern
- Hammers and Hanging Man
- Piercing Pattern and Dark Cloud
- Morning Star and Evening Star
- Harami Patterns
- Shooting Star and Inverted Hammer
- The Kicker Signal
- Three White Soldiers and Three Black Crows
- Three Inside Up and Three Inside Down
- Three Outside Up and Three Outside Down
- Concealing Baby Swallow
- Upside Gap Two Crows
- Advance Block
- Three Stars In The South
- Two Crows
- Unique Three River Bottom
- Moving Averages
- Elliott Wave Theory
- Oscillators/Indicators
Pips, Lots and Spreads
We told you that a quote might be something like EUR/USD 1.5535. This is known as the exchange rate, and now we are going to relate this to the pip value.
What is a pip?
PIP stands for Percentage In Point.
A pip is the smallest unit of measurement of the change in exchange rate for a given currency pair. It is the smallest price change that a given exchange rate can make. Since most major currency pairs are priced to four decimal places, the smallest change is that of the last decimal point - for most pairs this is the equivalent of 1/100th of one percent, or one basis point.
For example, the smallest move the USD/CAD currency pair can make is $0.0001, or one basis point. The smallest move in a currency does not always need to be equal to one basis point, but this is generally the case with most currency pairs. What does all this mean?
In forex, currency prices are typically quoted to the fourth decimal. For example, if the EUR/USD pair moves from 1.5510 to 1.5520 it has moved by 10 pips. If the EUR/USD increases by 1 full cent in value (from 1.5510 to 1.5610), it has increased by 100 pips.
The actual pip value will be different for each pair, and also different based on the exchange rate at any given time. To calculate the pip value, use the following equation:
pip value = 1 pip / exchange rate.
Lets see two examples:
EUR/USD 1.5535
pip value = 0.0001 / 1.5535 = 0.00006437
USD/JPY 107.95
pip value = 0.01 / 107.95 = 0.00009263
Okay, so now you know if you buy 1 "share" of EUR/USD and it goes up by 1 pip you will make a profit of $0.00006437. Not enough to buy a new car, but that is where lot sizes come in.
Lot Sizes
A "lot" is a unit of measurement for a contract size. A standard lot is 100,000 units. A mini-lot is 10,000 units. A micro-lot is 1,000 units.
Depending on the account, broker, and your own personal preferences, you can get lot sizes of 1,000 to 100,000 units. You can also trade multiple lots. The standard lot size is 100,000 units, so lets use that as an example with our EUR/USD pair.
You buy 100,000 units of EUR/USD 1.5536, which means you are buying 100,000 Euros at the cost of $155,360 USD.
A few hours later, you notice the quote is now EUR/USD 1.5563 (a difference of 27 pips) and you decide to close your position so you sell your 100,000 Euros and get back $155,630 USD for a profit of $270 USD. Notice that on a standard EUR/USD lot, each pip is worth about $10. If you had bought 2 lots instead of one lot, your profit would have been $540 USD. Not bad for a few hours work.
So what kind of commissions do you pay on that trade? Unlike stocks, options and futures, Forex trading doesn't involve commissions, clearing fees, exchange fees, government fees, or direct brokerage fees. Brokers are compensated for their services through something called “the spread”.
The Spread
Lets take the example of EUR/USD 1.5535 again. When you go to place a trade order, or even if you are just checking out the quote prices, you will often see something that looks like this:
Here you can see the actual currency pair and it's Bid and Ask prices. The difference between the bid and ask prices is called the spread. Different brokers use different values for the spread, and you generally want to stay in the 2-5 pip range or less for the spread. Here is why...
The spread is how the broker makes money. The larger the spread, the more it cuts into your profits.
The current quote for EUR/USD is 1.5536/1.5538, which means it has a 2 pip spread. The first number is the Bid price, and the second number is the Ask price.
Securities are bought at the ASK price (the price that sellers are willing to sell for) and sold at BID price (the price that buyers are willing to buy for).
Taking our earlier example, you buy 1 lot at the ASK price of 1.5538. The market moves up 27 pips, so you decide to close your order. The quote is now EURUSD 1.5563/1.5565 (this broker has a 2 pip spread on the EUR/USD pair.)
Now you sell your position for the BID price of 1.5563, netting you 25 pips instead of 27. 2 pips (or $20) goes to the broker for this trade. This might seem like a lot, but if you think about it, $20 is only 7.4% of the $270 gross profit. If the move would have been 100 pips, the gross profit would have been $1,000, less the $20 for the broker, for a net profit of $980. This equates to a trade fee of only 2%.
Regardless, it is a small price to pay, especially compared to all the fees and requirements that stocks, options and futures have. All that you need to really understand is that in order to be profitable on a trade, you must overcome the spread by at least 1 pip.
But, what if you don't have $100,000 to invest? Thats okay, because you don't need that much to start. You can start with as little as a couple hundred dollars using Leverage and Margin...
