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Until now, spot forex trading takes place in a definite amount known as “lots.” This means the number of currency units a trader will sell or buy.
100,000 units of currency are the standard size for a lot. Today, we have a nano, macro, and mini lot sizes ranging in 100, 1000, and 10,000 units respectively.
Remember that the change in the value of currency as it relates to another is measured in ‘pips’—a very tiny percentage representing a currency’s value unit.
You can take advantage of this minute change in value by trading a huge amount of a specific currency to record any significant gain or loss.
For example, using a standard lot size (100,000 units), let’s do some recalculations and see the effects it has on the pip value.
- USD/JPY exchanging at the rate of 119.80: {.01/119.80} x 100,000 =$8.34 for each pip.
- USD/CHF with a rate exchanging at1.4555: {.0001/1.4555} x 100,0000 =$6.87 for each pip.
In situations where the US dollar is not quoted at the beginning, the formula will be a bit different.
- GBP/USD exchanging at 1.8040 {.0001/1.8040} x 100,000 = 5.54 x 1.80×40 = 9.99416 when summed up will amount to $10 perp pip.
- EUR/USD exchanging at 1.1930: {.0001/1.1930} x 100,000 = 8.83 x 1.1930 = $9.99734 summed up will become $10 per pip.
Note that your broker may have a different rule for calculating the value of pips in relating to the lot size. However, no matter the formula they may use, you will be able to learn from them the exact pip value of the particular currency you are trading at that point in time.
As changes take place in the market, so will the pip value moves, depending on the currency you’re trading.
What is leverage?
Sometimes you might wonder aloud how on earth a low-level investor can conveniently trade such tremendous amount of money.
Well, start seeing your broker as a bank that typically empowers you with $100,000 upfront to buy currencies.
All that the bank requires from you is to provide a good-faith deposit of $1,000, which the bank will be holding for you, but not necessarily keeping it.
It sounds too good to be true, right? Well, this is how forex trading is making use of leverage.
The amount or volume of leverage you will use will largely depend on your broker and also what you feel will be comfortable for you.
Traditionally, your broker will demand a trading deposit (account margin or initial margin), which after depositing it with the broker, you will become empowered to trade. Furthermore, the broker will also let you know how much it will need per position (a lot) traded.
Here is an example, assuming the permitted leverage is 001:1 or just 1% of the position demanded, and you planned to trade a $100,000 worth position, whereas, you have just $5,000 in your account.
Don’t worry, since your broker will put aside $1,000 as the margin or down payment, which will then allow you to ‘borrow the rest’.
Yes, any gain or losses will be added or deducted to the remaining balance left in your account
The minimum margin or security for each lot varies from one broker to the other.
From the above-given example, a one percent margin was demanded by the broker. It, therefore, means that, for every $100,000 traded, a deposit of $1000 on the position is needed by the broker.
