What Are Forex Pips, Leverage, Margin And Lots?
Knowing the language and specific terminology of any business is necessary but is particularly essential in Forex trading. The difference between your trading in the Forex market being successful, or not, is knowing and understanding what pips, lots, margin and leverage are. Continue with the second part of this free Forex trading course to discover more about these important elements.
Understanding Pips And Lots
Pip is an acronym for ‘Percentage In Point’ movement, and it is how currency traders describe the change in a currency pair value. It is usually quoted to the fourth decimal point. For example, if AUD/USD moves up from 0.7316 to 0.7317, it can be said that the AUD has appreciated by one pip against the USD.
It is recommended that beginner traders measure loss or gain in a trading account by using pips instead of the actual currency value. It does not matter if the account is $10 or $1,000, in identifying a traders skill a one pip gain is a success, irrespective of the actual money gained, which of course is different.
When trading you will also hear the term, lots. Historically, specific amounts of currency traded were called lots. The standard size of a lot is 100,000, but you can also find mini lots of 10,000 or micro lots of 1,000.
Calculating Pip Value
The US dollar as part of a currency pair is probably the most traded. When the USD is the quote currency, second in the pair, and the account is US dollars, then the pip value is fixed.
- A lot of 100,000 worth of currency, it will be $10
- A lot of 10,000 worth of currency, it will be $1
- A lot of 1,000 worth of currency, the pip value will be $0.10
Understanding Leverage And Margin
Regarding the change in value, currency prices move very slowly. To make money trading them requires taking advantage of this small fluctuation, by trading more substantial sums. The concept of leverage and margins is one of potentially high risk, but one that most Forex traders adopt when short-term trading.
So, what is leverage? This process is where your broker can activate a loan to enable more contracts, larger lot purchases and more open positions. This allows you to trade in amounts more extensive than you actually have the cash for.
To be able to trade in this way a margin account with the broker needs to be opened. The margin is the amount of money placed in good faith, or as insurance, by the trader with the broker. For each position or trade, the broker will specify the margin, which then acts as collateral for the duration of the trade.
Margin required is always managed in the base currency, so for example, with EUR/USD it would be Euro.
It is usual to find leverage stated as 50:1, 100:1, and 200:1 for positions of under $50,000. What does this mean?
Looking at a 50:1 leverage ratio means that the margin required is 1/50, or 2% of the total value of the trade as cash in the trader’s account. So 100:1 ratio would need 1% of the total value.
It is vital that new traders grasp the leverage and margin concept in full. Failure to do so could see the broker liquidating your position if the losses look to be overtaking the margin deposit you have placed.
More From The Free Forex Trading Beginners Course
Part 1: Reading A Currency Quote
Part 2: What Are Forex Pips, Leverage, Lots, And Margin?
Part 3: Explore Currency Pairs And Their Different Aspects
Part 4: Fundamental Analysis And Technical Analysis In Brief
Part 5: The Use Of Forex Technical Analysis
Part 6: The Importance Of Fundamental Analysis For Forex
Part 7: You Need To Apply Some Psychology To Be A Successful Trader
Part 8: Finding The Best Forex Broker Online
Part 9: Disclaimer