If you’re a new or aspiring forex trader, you may still be wondering about some of the forex terminology. What are pips in forex trading, for example, and what about terms like margin, leverage and lots? Today we’ll ensure you understand all the key terms to progress faster in your forex education.
What is a Lot in Forex?
A lot in forex trading is a unit of measurement that standardises trade size set by an exchange or other market regulator. When trading currencies, buying or selling a single unit of currency simply isn’t practical, so lots exist to enable people to trade batches of currency in larger amounts. A lot represents a certain number of units of the base currency in a forex trade.
A standard lot in forex is equal to 100,000 currency units, but many retail traders are not trading 100,000 dollars, euros or pounds at a time, so there are also mini, micro and nano lots. A mini lot is 10,000 units, a micro lot is 1,000 units, and a nano lot is just 100 units.
Many retail traders, therefore, trade in micro lots, as this allows for smaller positions and more control over position sizes. Some brand-new traders on a small budget will be looking to access a broker that allows them to trade nano lots. More advanced and professional traders will generally be trading standard lots.
What is a Pip?
You’ve probably heard the term pips a lot while researching forex trading. A pip is essentially the smallest whole unit move that an exchange rate can make, and on currency exchanges, the bid/ask spread of a forex quote is always measured in pips. The value of a pip depends on the currency pair, the exchange rate and the trade value.
Most currency pairs are priced out to four decimal places, and a single pip is in the last decimal place, but there are exceptions, such as the Japanese Yen, which has an exchange rate that only extends to two decimal places.
As an example of how this works in practice, when the value of the EUR/USD pair goes up by one pip, the quote will move from 1.2345 to 1.2346, and the size of the movement is just one pip. When you choose a forex broker, you will see that the spreads for each currency pair are quoted in pips. As a trader, you are looking for lower spreads to maximise profit.
Be aware that when brokers quote the spread on each pair, they are factoring in their profit. For that reason, you can expect higher spreads, for example, from brokers who charge no other commissions or transaction fees, and lower ones from those who charge a separate fee per trade. The spreads on the majors are generally much lower than for less frequently traded pairs. Always check the spreads on the specific pairs you want to trade when comparing brokers.
An important guideline for the beginning trader is to measure success or loss in an account by pips instead of the actual dollar value. A one-pip gain in a $10 account is equal, in terms of the trader’s skill, to a one-pip gain in a $1,000 account, although the actual dollar amount is very different.
What is Leverage in Forex?
Leverage is borrowing a certain amount of money to invest in something. When it comes to forex trading, money is usually borrowed from a broker in the form of leverage which is quoted as a ratio such as 10:1, meaning that for every one unit of currency in your account, you can trade with ten units. It is not unusual for brokers to offer up to 30:1 leverage (the maximum allowed under current EU regulations) for forex traders trading major currency pairs. Some offshore brokers offer a lot more, sometimes as high as 500:1.
Leverage can be helpful as it allows traders to trade with far more capital than they have available and potentially make more profit than they would otherwise be able to realise. However, it can also be dangerous, especially for newer traders and, in particular, for those who do not fully understand how it works. Trading with leverage can amplify any losses as well as any profits.
For example, if you have $10,000 in your account and open a $100,000 position, you will be trading with ten times leverage on your account (100,000/10,000). A profit of 2% on the trade will be $2,000, but a loss of 10% would be $10,000, wiping out your account. It is essential to fully understand leverage if you are going to use it and to complicate matters slightly; leverage is also closely linked to something called margin.
What is Margin in forex?
When you open a forex account, the broker will request that you deposit a small sum, known as margin, as insurance against the losses that your account may suffer. With this small sum on margin, you’re able to control a much more considerable amount through leverage. This enables more significant gains but also greater losses than you would be able to achieve with your original deposit.
Using a combination of margin and leverage, the lots you can trade can be much larger. However, the capital you are using is effectively borrowed from your broker, who requires the margin deposit to guard against losses. You basically use margin to create leverage.
The ratio between the funds borrowed by you and the margin that you deposit as insurance is your leverage, although the actual leverage you use depends on the trade you make. For example, if you set a leverage ratio of 100:1, enabling the trade of 1,000,000 USD with just 10,000 USD in deposit, but eventually trade just 100,000, the actual leverage you would be using is 10:1.
The margin required is usually a small percentage of what you can theoretically trade, making a huge difference. For example, if you wanted to trade one standard lot without margin, with USD as your base currency, you would need $100,000 in your account. However, with a margin requirement of just 1%, you would only have to deposit $1,000 in your account.
To protect themselves, brokers impose a margin closeout policy. Margin closeout means all your open positions can be automatically closed by the broker if the amount in your trading account falls to the point that it no longer meets the margin requirement.
The Best Forex Brokers for 2022
If you are looking for a new forex broker, check out our table of top forex brokers to sign up with in 2022.
|#1||Your capital is at risk US Clients: No Regulated : Yes||
– 40% New Member Bonus
|#2||Your capital is at risk US Clients: No Regulated : Yes||
– Flexible leverage up to 500:1
|#3||75 % of retail CFD accounts lose money US Clients: No Regulated : Yes||
– Ultra – fast execution from 0.1s
|$100||from 0.0 pips|
|#4||Your capital is at risk US Clients: No Regulated : Yes||
||10€ / $ / £ (depends on account type and region)||1.2 pips|
|#5||77 % of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you can afford to take the high risk of losing your money. US Clients: No Regulated : Yes||
– FCA, ASIC, CySEC Regulated.
Hopefully, this article has helped answer some of your most pressing forex questions, such as “What are pips in forex trading?” and “What is margin in forex?”. However, you must continue your forex trading education and get very familiar with these concepts while starting to think about exactly how they will affect you, your trading strategies, and your risk management.
Understanding lots and pips will help you pick a forex broker that offers the types of spreads and lot sizes you are comfortable with. Margin and leverage allow traders to trade with more capital than they have but also present considerable risks. Not fully understanding those risks is a major reason new forex traders lose money. Being aware of these concepts and understanding what they mean can help your chances of forex trading success.
Next, part 3 >> Forex Order Types – Mechanics of Online Forex Trading >>
Previous, part 1 << How to read a Currency Quote <<
Forex Lessons in this Forex Trading Course:
Lesson 1: How to read a currency quote
Lesson 2: What are Forex Pips, Lots, Margin and Leverage
Lesson 4: Currency Pairs and Their Characteristics
Lesson 6: Forex Technical Analysis
Lesson 7: Forex Fundamental Analysis
Lesson 9: Choosing the Right Forex Broker