Technical aspects of Forex made easy
When you read this I will assume you can make out what the following means:
USD/JPY @ 114.55/114.60
I will still summarise in one line: The above says that US Dollars are being traded against Japanese Yen at a rate of 114.55 Yen/Dollar if you’re selling and 114.60 if you’re buying. The difference between the two rates is called the spread and usually values at 5 a pip.
A PIP is the last decimal place in a rate, or in other words the minimum value of increment/decrement in currency rates. Most currencies have a PIP of 0.0001, the Yen being an exception. It trades on a PIP of .01. We will now move on to PIP Values.
Don’t be confused, read on.
Assuming the USD as a constant for reference, consider the above example:
USD/JPY: 0.1 (the pip) divided by the exchange rate gives us the pip value i.e. 0.01/114.55 = 0.0000872
It might look like a complicated and apparently meaningless figure, but we’ll understand it better when you know about lots.
LOTS are simply, lots. When you purchase currency, you don’t purchase say one dollar or 5 dollars. That just sounds stupid. Instead, you purchase in lots of $100,000, as a standard. Nowadays, the smaller investor can purchase in mini-lots of 10,000 as well, something that wasn’t there earlier.
Now comes the interesting part: Calculating your profit or loss. Suppose you buy USD for Japanese Yen and are given the quote as above (refer beginning example). The rate you pay will be 114.60 and NOT 114.55, since you are a buyer. If you had been selling, the rate would’ve been 114.55. As a rule of thumb, remember that you pay more while buying, but get less when selling. So the rate for buying will be the greater value i.e. 114.60. Say you purchase a lot of $100,000 to enter trade. After sometime, you ask for a fresh quote and you’re given a quote of say 114.80/114.85. You’re in luck! The rates are high so if you sell now, you make a profit. You decide to sell and close the trade. The selling rate, or the bid, going by the thumb rule, is now 114.80. The difference between what you paid and what you will get is .20 or 20 Pips.
The profit is calculated as follows:
0.1/114.55 = 0.0000872 (Pip value) X 100,000 (lot) = 8.72 (per pip) X 20 (value changed by 20 pips) = 174.4.
Congratulations! You just made a profit of approximately $175!
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