Every day, thousands of people around the world invest in Australian forex. Whether they manage their accounts or work for a large institution, most traders need to know about pips and lots when conducting their business.
Pips are the smallest unit of measurement used in foreign exchange trading. They are the equivalent of 1/100th of one per cent, also expressed as 0.0001 (1/10). For example, if you see that EURUSD has moved 0.4554 pips, it means that the euro’s value against the US dollar has gone up by 4.55400 points since the opening price.
If you want to calculate how much money you have made or lost, you need to multiply this value by the size of your position.
Lots (also called lots sizes, contract size and nominal) define the amount of base currency per trade. For example, if your broker offers 10k lots, then you control a position worth $100,000.
The difference between pips and lots
While pips refer to an increase/decrease in the price of 1/100th of one per cent (0.0001), lots refer to the total value of base currency controlled per trade; there is no relationship between them at all. Meaning that if EUR/USD moves from 1.3000 to 1.2990 by 20 pips, a trader with a 100k EUR long position will have lost $2.00 in profit, while a trader with a 10k EUR long position would lose $0.20.
However, if the price of EUR/USD moves from 1.3000 to 1.2980, then both traders would lose the same amount: $20 in profit (since contracts are valued at $100k).
Pips and lots can be expressed by currency pairs too, not just by individual currencies: GBP/USD = 0.6180/1.6181 and 100k GBP means that each pip is worth $618.08 and each lot is worth $161,810.
When trading lots, most brokers offer a maximum margin of about 2% (so if the price moves by ten pips, then your account may be in debit by $200; you can check your current position margin requirements on OANDA’s calculator).
What are the advantages of learning about pips and lots?
Knowing what pips and lots mean is crucial if you want to be taken seriously as a forex trader; it demonstrates your understanding of the business and shows that you are serious about your career.
Many traders dream of trading large amounts like 100k or 200k EUR/USD contracts but don’t know the costs involved. While the cost is not prohibitive for professional brokers making high volume trades, less experienced traders will have to deal with decreasing returns from more significant positions because each pip move will result in a lower percentage increase in earnings.
If you think that 1% change equals approximately ten pips, then a 1000 lot trade will generate $8k in profit from a 1% move, but only $16 from a ten pip move. To benefit from more significant positions, traders need to have more capital to invest and thus bigger margin allowances.
Many traders don’t realise that the size of their lots is flexible. While most brokers offer default lot sizes (usually 100k), they also change this value based on traders’ preferences.
For example, if you have $100k to trade, choosing 10k lots will give you more flexibility to capitalise on small market moves than choosing 100k contracts.
Working with smaller lots/pips allows for greater granularity and precision, which can be extremely useful when trading with tight stop-loss orders or day trading very volatile currency pairs such as EUR/CHF during a news release session.
Many traders struggle with understanding breakeven points and calculating their risk/reward ratios.
While we can’t give you precise numbers for all currency pairs and time frames, an approximation is that a 1:100 risk/reward ratio requires a 4:1 reward, which will result in 200% of net profit from a 100 pips move on your long position.
Now that you understand more about pips and lots try your hand at forex trading with Saxo.