In the past, spot Forex was only traded in specific quantities called “lots”. The standard size for a batch is 100,000 units. There are also mini, micro and nano lot sizes equivalent to 10,000, 1,000 and 100 units respectively.
|Batch||Number of unitsé|
As you probably know, the change in the value of one currency relative to another is measured in Pips, which are very small percentages of the value of a currency unit. To take advantage of these changes in value, you must trade large quantities of a particular currency to recognize a significant gain or loss.
Suppose you are using a batch with a standard size of 100,000 units. We will therefore recalculate some examples to see how the Pip value is affected.
- USD/JPY at an exchange rate of 119.80 (0.01/119.80) x 100,000 = 8.34 USD per pip
- USD/CHF at an exchange rate of 1.4555 (0.0001/1.4555) x 100,000 = 6.87 USD per pip
The formula is slightly different in the case where the U.S. dollar is not the base currency.
- EUR/USD at an exchange rate of 1.1930 (0.0001 / 1.1930) X 100 000 = 8.38 x 1.1930 = 9.99734 USD rounded to 10 USD per pip
- GBP/USD at an exchange rate of 1.8040 (0.0001 / 1.8040) x 100 000 = 5.54 x 1.8040 = 9.99416 rounded to 10 USD per pip.
Your broker may propose different Pip calculation conventions depending on the size of the batch, but whatever its method, it will be able to tell you what is the value of the Pip inherent in the currency you are trading at any time. The value of the Pip changes according to the market and depends on the currency in which you are positioned.
What is leverage?
You may be wondering how a small investor like you can negotiate such large sums of money. Imagine your broker as a bank that would advance you $100,000 to buy foreign currency. All the banks require from you is a $1,000 advance from you representing a deposit of trust that he will manage for you without keeping it. Too good to be true? This is how the leverage effect on Forex trading works.
The amount of leverage used depends on your broker and what you are willing to risk.
In general, the broker will require a deposit on the account that serves as the”account margin” or”initial margin”. Once the money has been deposited, you can start trading. The broker will also tell you how many lots it is possible to trade on a particular position.
For example, if the authorized leverage is 100/1 (or 1% required on the position), and you want to trade a $100,000 position with only a $5,000 account, the broker would secure $1,000 in advance or “margin” and let you “borrow” the rest. Of course, any loss or gain will be deducted or added to the capital on your account.
The maximum margin of safety required for each batch varies among brokers. In our example above, the broker required a margin of 1%. This means that for every $100,000 traded, the broker requires $1,000 of deposit on the position.
How can I calculate profit and loss?
Now that you know how to calculate the value of the Pip and the leverage, let’s look at the calculation of profits and losses.
Let’s buy US dollars and sell Swiss Francs.
- The quotation price is 1.4525/1.4530. Because you buy US dollars, you will work on the offer price (Bid) of 1.4530 or the rate at which traders are preparing to sell.
- You buy a standard lot (100 000 units) at 1.4530.
- A few hours later, prices reach 1.4550 and you decide to close your trade.
- The new quotation for USD/CHF is 1.4550/1.4555. Since you are closing your position and have bought to enter the market, you are now selling to enter the price of 1.4550, the price at which traders are preparing to sell.
- The difference between 1.4530 and 1.4550 is 0.0020 or 20 pips.
- Using our previous formula, we now have (0.0001/1.4550) x 100,000 = 6.87 USD per pip x 20 pips =137.40 USD.
Remember that when you enter or exit a trade, you are subject to the bid/ask spread. When you buy a currency, you use the offer price and you use the demand price when you sell.
In the next article, we will provide you with a glossary of the Forex jargon you have learned!