Pips, lots and leverage

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Why do currency pair quotes have five decimal places?

Typically in forex, currency pairs display their prices with four decimal points. A few, such as the Japanese yen, display two decimal places. No matter what currency pair you're trading, the last large number behind the decimal always represents a pip, the main unit price that can change for the currency pair.

As you trade, you'll track your profits (or losses) in pips. One unit of movement represents one pip.

At Interactive markets, you'll also see a smaller number behind the pip - this is called a "fractional pip" and offers even more precise pricing. Sometimes, the fractional pip will be a 0 - that is, there will be no fraction of a pip being quoted at that time.

USD/EUR pricing example, represents a one-pip movement.

09:05 BST - 1.3037

09:10 BST - 1.3038

That may seem small and you may be wondering how forex can be worthwhile if all you're speculating on is fractions of a currency. Fortunately, forex is leveraged and traded in lots.

What is a lot?

In forex, a lot is a standard unit of measurement. At most forex dealers, one lot usually equals 100,000 units of currency. Whenever you place a trade, you start with one lot.

Fortunately, you don't need $100,000 in your account to trade the EUR/USD. In an Interactive Investor spot forex trading account, currency pairs usually have a 100:1* leverage ratio. This means you can control a large position ($100,000) with a small amount of money ($1,000).

Many traders find the leverage that most forex dealers offer very appealing. Nonetheless, you should know that trading this way can also be risky. It can produce substantial profits as easily as it can cause substantial losses.

*Customers who open through the US entity can have a maximum leverage of 50:1 on major currency pairs and 20:1 on exotic currency pairs.

How do pips, lots and leverage work together?

Let's imagine that you just closed a successful, one-lot EUR/USD trade. You earned 20 pips.

Your account is automatically set to display transactions in US dollars. Because you're trading the EUR/USD, that means:

0.0001 X $100,000 = $10 per pip

For your 20-pip trade, you would have earned $200.

Not all of the pips that you'll earn will be worth $10. The value of a pip depends on the lot size of your trade, how many lots you're trading, the currency pair and your account currency.

While you can manually calculate this or use online pip calculators to learn the value of a pip before you trade, most trading applications, like the Interactive Investor platform, automatically calculate pip values and convert them to the currency you're trading.

One lot traded on a standard account (Lot size 100,000 with a 100:1 leverage ratio)

SELL

USD/JPY 1.30200

20-pips movement in your favour

1.30000

BUY

Calculating your earnings

0.0001 x 100,000 = $10 per pip

(one lot)

For your 20-pip trade, you would have earned $200.

If you're ready to put all you've learnt into action, then why not open a spot forex trading account with Interactive Investor?