A standard forex contract for each individual open exchange transaction, corresponds to a predetermined unit of measurement of the value of 100,000 BCU. For example, if you issue a purchase order on the currency pair EUR/USD for a whole lot, you buy 100,000 units of euros and simultaneously you sell 100,000 units of dollars. Fortunately, with the trading leverage and margin mechanism, you do not need to move so big capital. With a leverage 1:100 it will be sufficient to commit 1/100 of the total amount (1%).
It is important to know pip value corresponding to each currency pair. The relationship between contract value and pip value is very important. Remember that a pip is the variation of each individual increase or decrease in a currency quote. For example, when you open a transaction, the currency pair EUR/USD is worth 1.5000/1.5002. After some time the same currency pair could be worth 1.5001/1.5003, increasing its value by 1 pip, or 1.4999/1.5001, decreasing its value by 1 pip. In this case, for a standard contract, 1 pip is worth 10 (euros or dollars depending on the currency of your account). If the set transaction is a long transaction, that is you have given a purchase order, each increased pip will result a gain of 10, each lost pip will result in a decrease of 10.
For example, you start with an initial capital of $ 5,000 and a leverage of 1:100. You open a position of buying a whole lot on a listing 1.5000/1.5002. Starting values are as follows: 5,000 (initial capital) – 600 (guarantee margin) = 4,400 (available balance). After a certain period of time the listing is 1.5002/1.5004. There was an increase of 2 pips. If 1 pip is worth 10, the gain will be 2 pips x 10 = +20. The new balance is as follows: 5,000 (initial capital) – 600 (guarantee margin) + 20 (net profit & loss) = 4,420 (available balance).
The pip value is not always the same for all pairs of currencies. For example, on currency pair EUR/USD, the 1 pip variation is 10, on pair USD/JPY is 8, on pair EUR/GBP is 17.
Calculating pips value
There are several reasons why you must consider the value of a single pip:
- On this value is calculated the broker spread amount. The spread is the cost of each transaction. When you place an order and this is executed, the forex trade broker immediately withdraws its gain. The gain is calculated on the difference between bid and ask. For example, if the currency pair EUR/USD is quoted 1.5000 (bid) /1.5002 (ask), it means that the spread is 2 pips. In this case, for each open operation, the broker will withdraw immediately from your available capital the pip value multiplied by two. If for every whole lot the pip value is 10, the broker gain will be 20 (2 x 10);
- On the pip value are calculated net profit and loss. In the previous examples it was not taken into account the transaction cost, to avoid complicating the explanation. By entering the operation cost, the example is modified as follows: 1,000 (initial capital) – 600 (guarantee margin) – 20 (spread) + 10 (value of 1 pip on the rise: 10) = 390 (available balance);
- The pip value allows you to calculate the distance from the market price at which to place take profit and stop loss. Knowing the pip value is useful to establish how much you can gain or lose with open operation. If you want to put a take profit or stop loss, know how much is worth 1 pip is very important. For example, if you placed a take profit of 10 points from the quoted value at the time of the position opening and the pip value is 10, it means that you decided to earn 100. If the value of 1 pip is 8 (USD/JPY) or 17 (EUR/GBP), the gain calculation will be different. The same considerations are valid for stop loss placement.
Spread and transaction closing
You should not operate only on one currency pair. EUR/USD is the currency pair treated more. Certainly, it is the one that has the lowest spread, on which you have more news and there is the greatest number of negotiations. However, there are days when the possibility of making good money with this currency pair is poor. In these cases, operating on other currency pairs can be interesting and convenient. In the forex market, the importance of a currency pair is given by the difference between bid and ask (spread). More the spread is low, greater will be the transaction volume.
It is important to note that the transaction closing mechanism takes into account the spread value. For example, you open a long position on a currency pair with spread 6. If you place a take profit, the transaction will be closed when the quoted value (ask) will reach the value you placed. The starting quotation is 100 (BID) /106 (ASK). You set a take profit to 120. So you expect a gain of 14 points (120 – 106). The operation will not be closed when the quotation will be 120/126, but when it will be 114/120.
Here are some clarifications:
- You must always check the available margin, especially if an open position is in loss or if you want to open other positions;
- If you have open positions in loss, the available balance is reduced progressively;
- When you open new positions the guarantee margin increases according to the leverage and the available balance is reduced;
- In a currency pair, spreads are expressed in the second quoted currency (ask). For example, if on the currency pair EUR/JPY quoted 155.88 / 155.90, you pay a spread of 2 for an operation on a whole lot, the value of the spread will be as follows: [(0.02 x 100,000): 155.90] = – 12.82;
- In a currency pair, gain and loss are expressed in the first quoted currency (bid). In the previous example, the gain/loss will be the following: [(0,02 x 100.000) : 155,88] = +/- 12,83. This information is important to establish levels of take-profit and stop loss;
- The guarantee margin amount varies according to the currency pair;
- The price line shown on the charts is the one of the BID value;
- The long operations are closed at the ASK price, short ones at the BID price.