What is Forex Trading? (Part 3)

(Continue Part 2)

Pip

Pip is an acronym for Point in Percentage. It represents the smallest amount of change in the rate of a currency pair and is a standardised unit. For a US Dollar based currency pair, like the AUD/USD, one pip is $0.0001. However, for some currencies, like the Japanese Yen (JPY), it is denoted as $0.001.

Pip value fluctuations have an effect on trading gains. For example, if you decide to buy €10,000 and the EUR/USD pair is trading at 1.1086, the price you will have to pay will be $(10,000×1.1086) or $11,086.

If the exchange rate for this pair sees a 5-pip increase, which means the EUR/USD is now trading at 1.1091, then to buy €10,000, you will have to pay $11,091.

What is the difference between pip and point?

A pip, or “percentage in point”, is the basic unit of measurement of price differences, while a point is the minimum amount of price change.

For example,

• The difference between 1.23234 and 1.23244 is 1 Pip.
• The difference between 1.23234 and 1.23237 is 3 Points.

Pip vs point

The formula used to define the relationship between these two terms is:

1 pip = 10 points
Thus a point is 1/10th of a pip.

Pip Size

A pip size is a number that indicates the placement of the pip in a price, which for most currency pairs is a standard value of 0.0001.

For example, the pip size for EURUSD is 0.0001. This means that if we look at the price of EURUSD at any given point in time, the 4th place after the decimal point is the pip. This means the point is the 5th place.

There are currency pairs that have a pip size of 0.01, for example XAUUSD. This means that for XAUUSD, the pip is the 2nd place after the decimal point, and the point is the 3rd place.

The table below lists the pip sizes for trading instruments with different price formats.

	Standard currencies	Gold, Silver, JPY	Cryptocurrencies
Price format	EURUSD: 1.21568	USDJPY: 113.115	BTCUSD: 6845.25
Pip	4th decimal	2nd decimal	1st decimal
Point	5th decimal	3rd decimal	2nd decimal
Pip size	0.0001	0.01	0.1

Pip size is a very important tool in various calculations, the most common one being spread.

Majors, Minors and Exotics

Not all currency pairs are traded in large volumes. The US Dollar, being the world’s reserve currency, is definitely traded the most; although, over the years, its dominance has waned somewhat. Based on how frequently they are traded, currency pairs are segregated into major, minor and exotic categories.

Majors	Minors	Exotics
Major currency pairs have the tightest spreads. They are: – EUR/USD: Euro/US Dollar (aka Fiber) – GBP/USD: British Pound/US Dollar (aka Cable) – USD/JPY: US Dollar/Japanese Yen (aka Ninja) – USD/CHF: US Dollar/Swiss Franc (aka Swissy) – CAD/USD: Canadian Dollar/US Dollar (aka Loonie) – AUD/USD: Australian Dollar/US Dollar (aka Aussie) – NZD/USD: New Zealand Dollar/US Dollar (aka Kiwi)	Then comes a category of minor currency pairs, otherwise known as cross-currency pairs. They are called so because they do not include the US Dollar. So, to convert one into the other, the US Dollar will need to act as a mediating currency. A few of the minor pairs are: – EUR/GBP: Euro/British Pound (aka Chunnel) – EUR/AUD: Euro/Australian Dollar – CHF/JPY: Swiss Franc/Japanese Yen – GBP/JPY: British Pound/Japanese Yen (aka Gopher) – GBP/CAD: British Pound/Canadian Dollar	Exotics can include a major currency with an emerging market currency. Trading in exotics is considered risky, since they tend to have low liquidity, wider spreads and political instabilities in these countries can make these currencies volatile. Some examples are: – EUR/TRY: Euro/Turkish Lira – USD/HKD: US Dollar/Hong Kong Dollar – AUD/MXN: Australian Dollar/Mexican Peso In the brackets are the common nicknames for these currency pairs.

Going Long or Going Short

When you assume a long position in a currency pair, you buy a currency in the hopes that its price will rise (appreciate) in the future. This means you wish to buy the base currency and sell the quote currency, since you expect the base currency to appreciate with respect to the quote currency.

When you assume a short position in a currency pair, you sell the base currency, expecting it to depreciate (decline in price) in the future, allowing you to buy it at a later date but at a lower price.

Lot Sizes

When you decide on your position size, a term you will hear is “lot.” Lots are standardised position sizes for currencies. The forex market gives you the flexibility to trade according to your means and risk profile. The standard size for a lot is 100,000 units of the base currency. There also are mini and micro lot sizes that contain 10,000 and 1,000 units of the base currency, respectively.

What is Liquidity in Forex Trading?

Liquidity in the forex market refers to the ability of a currency to be bought or sold on demand. When you trade in major currency pairs, there are a lot of buyers and sellers in the market. This means that there is always likely to be an opposite player for every position you take. You can buy or sell large amounts of these currencies without causing any significant difference to the exchange rate.

Liquidity fluctuates during trading sessions. You are likely to see significant activity during the overlapping of the New York and London sessions. Depending on your style of trading, you could benefit from choosing specific trading sessions. For instance, short term traders prefer the US or London sessions, when large price breakouts and percentile movements tend to occur. The Tokyo session is often range-bound, which might not be the best for them.

Liquid markets, such as forex, tend to fluctuate by smaller increments, since high liquidity means less volatility. However, high volatility can occur due to significant external events.

The Concept of Leverage in Forex Trading

Leverage in forex trading is a useful financial tool. It allows traders to gain greater exposure to market movements than they could otherwise afford. So, this means a trader can enter a position worth $100,000 with just $1,000 in their account, with a 100:1 leverage ratio.

The leverage amount is provided by the forex broker. Consider it as a loan, which can help you to increase your gains with little price increments. However, also remember that leverage magnifies your losses too, if prices move in the wrong direction. This is why, it is important to put in place robust risk management strategies while trading.

When you decide to trade, you need to open a margin account with a regulated broker. Here, you will need to deposit an initial margin amount that is required to keep your leveraged positions running.

This is also called deposit margin. When the amount drops below the minimum level, your broker will issue a margin call. This means that you need to deposit funds to keep your positions open. Otherwise, the broker may close your positions.

A 50:1 leverage ratio means a minimum margin requirement of 1/50 or 2% of the total trade value from you. Similarly, a 100:1 leverage ratio means that you need to deposit at least 1% of the total value of your trade in your margin account.

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Read What is Forex Trading? (Part 1)