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CHAPTER 2 - LESSON 2
Pips and lots are two essential concepts in forex trading. Understanding these is crucial for calculating profits and losses, managing risk, and developing effective trading strategies.
Let’s define pips and lots below:
A pip is the smallest unit of price movement in a currency pair.
• Most currency pairs are quoted to four decimal places, and the pip is the fourth decimal place. For example, if the exchange rate of the EUR/USD pair changes from 1.1500 to 1.1505, this represents a movement of 5 pips.
• The value of each pip is determined by the currency pair being traded, the size of the trade, and the exchange rate.
A lot is the standardized unit of trading in the forex market. The size of a standard lot is typically 100,000 units of the base currency.
• This means that when trading a standard lot, the value of one pip is equal to $10 for most currency pairs.
• There are also mini lots (10,000 units of the base currency) and micro lots (1,000 units of the base currency) available for traders who want to trade smaller positions.
Understanding pips and lots is essential for calculating profits and losses in forex trading. For example, if a trader buys 1 standard lot of the EUR/USD pair at an exchange rate of 1.1500 and sells it at an exchange rate of 1.1510, they would have made a profit of 10 pips, or $100 (10 pips x $10 per pip).
Conversely, if the trader had sold the same lot at the same exchange rate and closed the position at an exchange rate of 1.1490, they would have made a loss of 10 pips, or $100.
When trading forex, it is important to consider the value of each pip and the size of the lot being traded in order to manage risk effectively. Traders should also be aware of the impact of leverage on their trades, as leverage can magnify both profits and losses. In the next section, we will explore another essential concept in forex trading: the bid-ask spread.
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