If you want to trade currencies, you need to understand the concept of pips in order to work out your cost of doing business as well as your profit and loss, on open trades. A “pip” stands for “Percentage in Point”. A pip is the smallest price movement a traded currency can make and is also referred to as a “point”. Lets look at and explain, the basics of understanding Forex pips in more detail...

Lets first, look at the Forex pip calculation, lot sizes and pip spreads....

How Pips are Calculated

For most currencies a pip is 0.0001 or 1/100 of a cent and most currencies are traded in lots of $100 000. For that amount a pip is $10. When a currency moves from a value of 1.5011 to 1.5014, it moved the equivalent of 3 pips because a pip has a value of $10, you have made $30.00. The only exception is for quotations for Japanese Yen against other currencies. For currencies in relation to Japanese Yen a pip is 0.01 or 1 cent – so if you are trading $100,000 lot of USD/JPY, one pip will be equivalent to $1000 in profit or loss.

Lot Sizes

Typically, one standard lot is equal to 100,000 units of the base currency but brokers offer smaller sizes for retail traders, who have limited funds and offer:

10,000 units if it's a mini, or 1,000 units if it's a micro. Some dealers offer the ability to trade in any unit size, down to as little as 1 unit. The pip value for EUR/USD is always $10 for standard lots, $1 for mini-lots and $0.10 for micro lots.

Liquidity Volume and Pip Spreads

As a general rule the more active and bigger the volume of the pair traded, the lower the pip spread. So a high volume pair such as EUR/USD, will have tighter spreads than a lower volume currency pair such as USD/NZD, smaller and exotic markets tend to have a higher spread and all brokers will be offering different spreads for different currencies depending on volume and liquidity and smaller accounts will sometime be given higher spreads than bigger accounts.

Pip Spreads and the Impact of Leverage

The pip spread is your cost of doing business In the case of a 3 pip spread, this means you sustain a loss equal to 3 pips at the moment you enter the trade so you need to cover this loss and make a profit on your trade, also note this key error novice traders make:

If you are leveraged up highly, the cost of doing business is calculated on your deposit, so be careful not to over leverage or you will soon find yourself having to cover 10% or more on your trade, just to break even. Using to much leverage, not only increases the risk of the trade, it also hits you with a bigger cost of business in relation to your deposit to break even. While this should be obvious, most traders over leverage and soon get wiped out so don't make the same mistake use leverage conservatively.

How Many Pips should You Pay With a Broker?

Your contract has to appreciate by 3 pips before you break even. The lower the pip spread the easier is it for you to profit. From the profitability point of view it is important to find a broker offering a low pip spread generally you should look at around 3 pips on the majors and 5 pips on secondary currencies.

Don't just go for the tightest pip spread, if you have the above pip spreads, you can easily make money on trades without commission impact – always make sure that the broker you are trading with is regulated and avoid market makers who make money when you lose.

There are many brokers today who will give you fair pip prices and with the cost of doing business so low in Forex trading, its a great market to make profits in.