Spot Forex is traditionally traded in lots and also most of the time referred to as contracts. The standard size/contract for a lot is $100,000. As the forex market opens up in the last few years, mini lot size has been introduced at $10,000 and this again may change in the years to come.
As I have covered on PIPS in my last post, PIPS is the smallest increment/decrement unit of a currency. To take advantage of these tiny increments in PIPS value, it is necessary to trade large amounts of a particular currency in order for us to see any significant profit or loss.
I shall cover the leverage portion of Forex trading in a later post. But for the discussion, I will assume that you have the ability to purchase a standard/contract at $100,000.00. I will show you now how to recalculate some examples in The Mechanics of Currency Markets - PIPS to see the actual value of each pair of currency.
Take for example, USDCAD at 1.0915, the value of 1 pip would be 0.0001/1.0915 = 0.0000916. The actual value of 1 pip in dollars and cents will be 0.0000916 * $100,000.00 = $9.16.
USDJPY at 93.95, the value of 1 pip would be 0.01/93.95 = 0.0001061. The actual value of 1 pip in dollars and cents will be 0.0001061 * $100,000.00 = $10.61.
EURUSD at 1.4301, the value of 1 pip would be 0.0001/1.4301 * 1.4301 (exchange rate) = 0.0000699 * 1.4301 = 0.0001 (round up). The actual value of 1 pip in dollars and cents will be 0.0001 * $100,000.00 = $10.00.
GBPUSD at 1.6267, the value of 1 pip would be 0.0001/1.6267 * 1.6267 (exchange rate) = 0.0000614 * 1.6267 = 0.0001 (round up). The actual value of 1 pip in dollars and cents will be 0.0001 * $100,000.00 = $10.00.
Different brokers might have a different way of calculating the PIPS value relative to the lot/contract size, but they will be able to tell you the PIP value for the currency that you are trading at that moment of time. But, that is not important, you need to remember, as the market moves, the value of PIPS will also change.
I have already shown you how to calculate the PIP value. Now, I shall show you how it is related to the lot/contract size.
EUR/USD is quoted at 1.4334/1.4336. You would like to buy 1 Lot of EUR and sell US Dollars. The rate that you have to look out for will be 1.4336, the rate that other traders are prepared to sell. You proceed to buy 1 Lot of EUR at 1.4336. The price increase and you have a re-quote of the EURUSD pair at 1.4396/1.4398. To close your trade, you need to look at 1.4396, the price that traders are willing to buy from you. The gain in pips is 60 pips.
EURUSD at 1.4396, the value of 1 pip would be 0.0001/1.4396 * 1.4396 (exchange rate) = 0.00006946 * 1.4396 = 0.0001 (round up).The actual value of 1 pip in dollars and cents will be 0.0001 * $100,000.00 = $10.00. The gain in 60 pips will be 60 * $10.00 = $600.00.
Next, if you are looking to trade in USDJPY. The quotes given at that time is 93.13/93.15. You are to sell US Dollar and buy Japanese Yen. The quote that you should look out for is 93.13, the price that other traders are willing to buy from you. The price drops to 92.81/92.83 in a few hours time. You now look to close your trade at 92.83, the price other traders are willing to buy from you. The gain in pips is 30 pips.
USDJPY at 92.83, the value of 1 pip would be 0.01/92.83 = 0.00010772. The actual value of 1 pip in dollars and cents will be 0.00010772 * $100,000.00 = $10.77. The gain in 30 pips will be 30 * $10.77 = $323.10.
The reverse calculation is true for losses.
Just a simple recap, when you buy a currency you will use the Ask price and when you sell a currency, you will use the Bid price. As can be seen from this, you will only pay spread when you buy currencies. But to note, spread are being paid per trade as each trade involves buy and sell each time.
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