Part of trading in the forex market is understanding lots and pips. These two key elements of the forex market will determine how much you are selling and buying and the profit you make.
When you buy eggs from the store, you don’t buy one single egg. Instead, you are buying a “lot” of 12 eggs. A lot is essentially the number of units in one purchase. In the forex market, you don’t buy one unit of currency; you buy one lot of currency, typically in the following amounts:
- 1,000 units (micro-lot)
- 10,000 units (mini-lot)
- 100,000 units (standard)
The amount you buy will depend on your broker and the type of account you are trading. How these lots convert into money has to do with the pips.
A “pip” is a unit of measurement that is used to show the difference in value between two currencies. For example, if you are trading EUR/USD, where EUR is 1.1050 and USD is 1.1051, then you would subtract EUR from USD in the following equation:
1.1051 – 1.1050 = 0.0001 USD = 1 pip
Typically, the pip is the last decimal place of a price quote. The pip is basically the value of your currency in terms of the exchange rate.
Suppose you’re trading USD/CAD. The exchange rate is at one pip and the exchange rate is expressed in terms of the base currency being equal to 1:
1 USD / 1.0200 CAD
To determine the value of each USD per unit traded, you would use the following equation:
[0.0001 CAD] x [1 USD//1.0200 CAD]
Which would be the same as:
[(0.0001CAD)/1.0200CAD)] x 1 USD = 0.00009804 USD per unit traded
That would mean for every mini-lot you sell of USD/CAD, there would be a one-pip change to the exchange rate, totaling about a 0.98 USD change in the position value.