Pips, margin, leverage and lots in Forex trading

Knowing and understanding the proper terminology within the forex market is essential in becoming a successful trader. What are FX pips, margin, leverage and lot in forex trading - in this article we will discuss and define what they are. We also provide examples of each to make it easier for novice traders to understand.

Forex pips and lots

Currency traders quote the value of a currency pair, and trade sizes, in pips and lots. Let's take a closer look at what pips and lots are in online trading.

Lots are the smallest amount of the security that can be traded and pips are the smallest amount a currency quote can change. Pip value is a measure that reflects how a one-pip change impacts a dollar amount and leverage is the amount of money you have available as a borrower.

Pips usually represent the smallest price swings that the value of a currency pair can change on a chart in a trading terminal. Some brokers also use fractional pip quotes. In example, when the value of the EUR/USD pair goes up by one tick (pip) the quote will move from 1.2345, to 1.2346, and the size of the movement is just one pip. 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 1 pip gain in a $1,000 or 100k account, although the actual dollar amount is very different.

The smallest size in currency trading for professional traders is called a forex lot. For USD-based pairs, the lot size is 100,000. In other words, when you open a margin trade, the standard volume you can buy or sell is 100k, regardless of your margin size. You can trade both whole and fractional lots from 0.1, etc.

Forex margin and leverage

Another important concept in currency trading is the twin phenomenon of margin and leverage. This is a concept that carries a high degree of risk, but since forex prices move very slowly (in terms of the actual change in value), the vast majority of traders leverage their accounts when engaging in short-term trading.

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, you're able to control a much larger amount, enabling greater gains, but also greater losses than you would be able to achieve with your deposit. It's easier to understand margin and leverage in the context of a borrowing process. The lots that you can trade are borrowed from your broker, who requires a margin deposit as an insurance against losses. The ratio between the funds borrowed by you, and the margin that you deposit as insurance is called leverage. Thus, if you set a leverage ratio of 100:1, enabling the trade of $1,000,000 with just $10,000 in deposit, but eventually trade just 100,000, the actual leverage that you would be using is 10:1. Note that forex leverage over 50:1 is not available to traders in the U.S.

In order to understand how to manage your account you must gain a good understanding of leverage. Failure to pay proper attention to leverage and margin may result in a margin call and the broker may liquidate your position in order to ensure that your losses do not reach a level where your margin deposit is insufficient to cover them.

Important! Be careful when using high leverage as increasing leverage also increases your risk.

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