All Financial Wisdom
Trading in Forex: What are pips and lots?
To get into the world of Forex, the first fundamental lesson should be to fully understand what the pips consist of and how they work.
Surely, you have heard these terms on a number of occasions, but although it may seem that these are very simple concepts, they have their complexity for anyone who is not used to them.
What is a pip?
A pip in Forex represents the minimum movement of the price that can make the pair that is being traded. In particular, the pip is the last decimal of a given pair price (in the case of most important pairs it is the 4th decimal, except for the dollar/yen, in which the pip is the 2nd decimal).
For example, if the euro/dollar trades at any given time at 1.1352, ie, that each euro equals $1.1352, the pip would be 2. In the case where the price moves from 1.1352 to 1.1355, the movement of the quote corresponds to 3 pips.
For Forex trading, it is much more convenient to use the pips to account for the losses and gains of our trade, since working with 0.0001 units is not at all intuitive.
How do lots work?
The other important element to be able to understand the impact of each of our Forex trades is to understand how the batch works .
In practice, lots are the units of base or reference currency (the one on the left, the one on the right is known as the counter currency) that we buy from a certain pair. For example, if we buy lots of euro/dollar, we are buying euros. How many euros? Exactly 100,000 units per lot. In the event that we buy 2 lots, for example, we are buying 200,000 euros.
But one of the great advantages of Forex is the possibility of working on mini lots or even micro lotes , which correspond to 10,000 units, and/or 1,000 units of the base currency respectively. For example, if instead of buying 2 lots of euro/dollar we buy 2 micro lots, we are disbursing 2,000 euros instead of 200,000. With this much lower minimum, we can start investing in Forex starting from much lower initial amounts than if we begin directly with lots.
Do not be scared with these figures, as it is not necessary to pay the total amount of base currency that is being bought at any time for the mighty idea of “leverage” will be provided by your Forex broker. That is, it is possible that your broker will allow you to buy 100,000 euros (1 lot) of the euro/dollar by having only 1,000 euros (leverage 1: 100) in your account. By the same rule, you could buy 1,000 euros (1 microlote) with only 10 euros. But the dangers of leverage will be explored later.
How much is each pip worth?
Let’s illustrate this with an example. If we bought 1 lot of euro/dollar and in the trade we won 50 pips, we would be talking about a profit of $500. This would only be $50 if we bought a mini lot, and only $5 if what we bought was a micro lot. To know the value of the pip in euros, we will divide those values into dollars by the current pair price. If the euro/dollar is at 1.1352, for example, the $50 would become 44,0451 euros.
It is clear that in order to limit losses during learning, micro lots are a most interesting tool, since they replicate the same trading strategy as the lots, but they significantly limit the economic impact on our account, thus preserving capital, one of the fundamentals when it comes to trading.