Pips and lot sizes

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Very common terms used by forex traders are “pips” and “lot sizes”. Pip stands for:

The foreign exchange (also known as FX or forex) market is a global marketplace for exchanging international currencies. For example, you can trade the euro with usd or the Japanese yen with usd and many more. 

Most of these currency pairs are priced with four decimals. The last decimal is called a pip. A pip is one hundredth of one percent (0.0001). A pip is the smallest move a pair can make. Pip is used to determine how much profit or loss is made or how big the spread (price difference) is between the bid and ask prices. There are a few exceptions where 1 pip is not equal to 0.0001:

There are also fractions of a pip, these are called pipettes. For example:

When the EUR/USD moves from 1.2171 to 1.2172, the change is one pip. When the 5th decimal changes from 3 to 4 the change is one pipette. It’s good to know but almost no one uses pipettes in trading.

4.1 Lot sizes and how to calculate the value of a pip

Trading pairs consist of two parts:

The base currency is the first currency in a pair. For example, for the pair EUR/USD the base currency is EUR and the quote currency is USD. Lot sizes are based on the base currency while the value per pip is calculated with the quote currency. The value per pip will always be the same when using the same quote currency. 

The lot size determines how much units of base currency you want to trade. You can have different sized lots:

If you are trading EUR/USD with a standard lot that means that every pip has a value of $10. This is calculated by multiplying 100.000 units with 0.0001 (1 pip) = $10.  The value per pip based on lot size will be:

If you are trading a JPY/USD currency pair (or gold, metal and US30) you have a different pip size (0.01 instead of 0.0001) so the value per pip also changes with two decimals:

When you know the lot sizes and the value per pip you can now determine how much profit or losses you make when looking at price movements measured in pips. For example:

When the Euro / U. S. Dollar prices moves up from 1.1271 to 1.1281 you got a 10 pip move.

When you are trading 100.000 units of a currency that means you are trading with €100.000 (when trading the Euro / U.s. Dollar market). Since you probably don’t have €100.000 lying around, you will almost never use standard lots. Unless you start using leverage. With leverage you can borrow money from your broker to enter positions that would be normally off limits because you don’t have the capital. I will go in-depth about leverage later on. 

To make more sense out of pips and lot sizes, you can think about it this way:

When you are buying one standard lot in the Euro / U. S. Dollar market you are telling your broker to spend €100.000 to buy U.S. Dollar at the current exchange rate. 

When the price moves up 10 pips from $1.1271 to $1.1281 you gained $100 like we calculated before. 

Be aware that lot sizes are not static. Some brokers allow you to determine your own lot sizes. 

4.2. Value per pip for other quote currencies

You might get confused when you are using pairs that have another quote currency. The quote curreny is the second currency listed in the currency pair. For example, when trading USD/JPY, JPY is the quote currency. Because JPY is the quote currency, the value per pip changes from the above examples. You can calculate the value per pip as follows:

For example, the USD/JPY market is trading for 113.518. Meaning for $1 you get 113.518 Yen. If we have a position size of 3 mini lots (30.000 units) the value per pip will be:

The calculation is done with the current quote currency and the outcome is the value per pip in base currency. And this is exactly what you want when trading markets when using your base currency (mostly EUR or USD).