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As we mentioned on the previous page
currencies are measured in pips, which is the smallest
increment of that currency.
To take advantage of
these tiny increments it is desirable to trade large
amounts of a particular currency in order to see
any significant profit or loss. We shall cover leverage
later but for the time being let's assume that we
will be using $100,000 lot size. We will now recalculate
some examples to see how it effects the pip value.
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USD/JPY at an exchange rate of 116.73
(.01/116.73) X $100,000 = $8.56 per
pip
USD/CHF at an exchange rate of 1.4840
(0.0001/1.4840) X $100,000 = $6.73
per pip
In cases where the US Dollar is not
quoted first the formula is slightly different.
EUR/USD at an exchange rate of 0.9887
(0.0001/ 0.9887) X EUR 100,000 = EUR
10.11 to get back to US Dollars we add a further
step
EUR 10.11 X Exchange rate which looks
like EUR 10.11 X 0.9887 = $9.9957 rounded up will
be $10 per pip.
GBP/USD at an exchange rate of 1.5506
(0.0001/1.5506) X GBP 100,000 = GBP
6.44 to get back to US Dollars we add a further
step
GBP 6.44 X Exchange rate which looks
like GBP 6.44 X 1.5506 = $9.9858864 rounded up will
be $10 per pip.
As we said earlier your broker might
have a different convention for calculating pip
value relative to lot size but however they do it
they will be able to tell you what the pip value
for the currency you are trading is at that particular
time. Remember that as the market moves so will
the pip value depending on what currency you trade.
So now we know how to calculate pip
value lets have a look at how you work out your
profit or loss. Let's assume you want to buy US
Dollars and Sell Japanese Yen. The rate you are
quoted is 116.70/116.75 because you are buying the
US you will be working on the 116.75, the rate at
which traders are prepared to sell.
So you buy 1 lot of $100,000 at 116.75.
A few hours later the price moves to 116.95 and
you decide to close your trade. You ask for a new
quote and are quoted 116.95/117.00. As you are now
closing your trade and you initially bought to enter
the trade you now sell in order to close the trade
and you take 116.95 the price traders are prepared
to buy at. The difference between 116.75 and 116.95
is .20 or 20 pips. Using our formula from before,
we now have (.01/116.95) X $100,000 = $8.55 per
pip X 20 pips =$171
In the case of the EUR/USD you decide
to sell the EUR and are quoted 0.9885/0.9890 you
take 0.9885. Now don't get confused here. Remember
you are now selling and you need a buyer. The buyer
is biding 0.9885 and that is what you take. A few
hours later the EUR moves to 0.9805 and you ask
for a quote.
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You are quoted 0.9805/0.9810 and you
take 0.9810. You originally sold EUR to open the
trade and now to close the trade you must buy back
your position. In order to buy back your position
you take the price traders are prepared to sell
at which is 0.9810.
The difference between 0.9810 and 0.9885 is 0.0075
or 75 pips. Using the formula from before, we now
have (.0001/0.9810) X EUR 100,000 = EUR10.19: EUR
10.19 X Exchange rate 0.9810 =$9.99($10) so 75 X
$10 = $750.
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To reiterate what has gone before,
when you enter or exit a trade at some point your
are subject to the spread in the bid/offer quote.
As a rule of thumb when you buy a currency you will
use the offer price and when you sell you will use
the bid price.
So when you buy a currency you pay
the spread as you enter the trade but not as you
exit and when you sell a currency you pay no spread
when you enter but only when you exit.
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