How Pips Are Used in Currency Trading
A pip refers to percentage in point and is used in forex trading. It is the smallest change in value or move in a given currency. Most currency pairs (USD/CAD, USD/EUR) are priced to the 4th decimal. If a currency pair like GBP/USD trades at 1.5731, then the price ratio increases by 31 pips. One British pound is equal to 1.57 USD in this example.
Pips are used to calculate losses and profits. While their values look very low, currencies usually trade in large lots. The pip is $10 for a lot of $100,000 if the ratio is 1/100 or 0.0001. When a currency moves from 1.512 to 1.516, it moves 4 pips. Thus you will gain $40 if the pip is $10. The Japanese Yen is one exception to the rule. If an investor trades USD/JPY in a mini lot of 10,000 units, the pip is equal to $100. It is 1 cent or 0.01 in this case.
Types and Spreads
There are 3 types of lots – micro, mini, and standard lots. The micro lots are equal to 1,000 units, the mini lots to 10,000, and the standard lots are 100,000. Generally, a standard lot of 100,000 units is the minimal amount that is traded in currency transactions. Some people trade in mini and micro lots through mini accounts. The profits are lower for micro lots, which means that the losses are also lower. The risk is also lower while forex trading is a risky investment. An investor can lose $0.10 for a micro lot and $1 for a mini lot. Apart from trading smaller lots, investors use other strategies that help minimize risk and loss. These include scalping, hedge techniques and trailing and protective stops.
The pip spread is also important for forex traders. It is equal to the difference between the bid and ask or the selling and buying price. The spread determines how profitable an investment is. Some currency pairs bring larger profits than others. Second, a smaller spread doesn’t mean that an investment is more profitable and vice versa. Traders establish a base line to determine which currency pairs bring higher profits and are good for day trading. They look at profits, the pip potential, and the spread. To do this, they convert spreads to percentages.
As a rule, the larger the spread, the more impact it has on trading. Some investors underestimate this fact because they don’t pay a commission for trading. The spread is the cost traders pay for investing. Let’s say that the currency pair EUR/CAD is quoted at 1.4602 bid and 1.4606 ask. The spread will be 4 pips, which means that the investor risks losing money equal to 4 pips. Lower spreads make it easier for investors to profit.
Generally, the pip spread is low in large and active markets. The spread also depends on the currencies that are traded. It is higher for micro accounts than for standard accounts. To make profit, investors should find a reputable broker with extensive experience in forex trading. They usually offer low spreads. Active investors who trade on a daily basis usually choose currency pairs with the lowest spreads.
Finally, investors use electronic trading platforms to gain access to the forex market. They are beneficial in that platforms increase price competition and transparency. Investors use different tools such as features for account management, news feeds, and charts, among others.
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