Now we understand how pips work we need to understand how to calculate the value of a pip. The easiest way to calculate a pip value is to use standard lots as an example. We will then adjust our calculations in order to find the pip value on mini lots, micro lots and other lot sizes.
The first thing we need to consider is in which currency we want to calculate pip value. By default the pip value first is calculated in the quote currency (and not the base currency).
Let’s say we want to understand the pip value of 1 lot of EURUSD in USD and let’s also assume that our account’s base currency is the USD.
100,000 * 0.00010 (1 pip) = $10 pip value of 1 lot EURUSD
Now, let’s say we want to understand the pip value of 1 lot of EURUSD in EUR because our base currency is the EUR. We do the same calculation but divide the answer by the price of the currency pair, as outlined below.
100,000 * 0.0001 (4th decimal)=$10 / 1.3600 (Market rate of EURUSD) ~€7.35 pip value of EURUSD (rounded)
Now, let’s say we want to understand the pip value of 0.1 lot (mini lot) of EURUSD in USD we calculate the following:
10,000 * 0.00010 (1 pip) = $1 pip value of 0.1 lot of EURUSD
Finally, looking at the pip value of 0.01 lot (micro lot) of EURUSD in USD we calculate the following:
1,000 * 0.00010 (1 pip) = $0.10 pip value of 0.1 lot of EURUSD
After explaining that 1 lot is 100,000 units of a currency and the smallest micro lot is 1,000 units of currency you may be thinking that you cannot deposit $100,000 with a broker in order to trade Forex. Well, fortunately in order to take part in Forex trading you don’t need all of that money as an available balance. The reason why is down to leverage, which brokers offer on nearly all trade accounts and is standard practice in financial trading. Leverage may be referred to as 100:1, which essentially multiplies your deposit by 100 times. This means that you can trade 1 lot ($100,000) with just $1,000 when you have a leverage of 100:1. The advantage of this is that you can take part in sizeable trades without the necessary funding. The net profit/loss that can be incurred from a trade is huge (potentially 100x your equity in this case). Leverage is a tool that allows individuals to take part in large trades without the necessary financial backing, allowing them to make huge gains if they trade successfully. However by the same token it enables the trader to incur great losses if the markets turn against them and in some cases have the ability for the markets to wipe out more than their entire balance.. For this reason it is advisable not to open positions that multiply the traders balance with the full leverage available, as it is very high risk and the trader is highly likely to incur huge losses. Instead using a small part of the available leverage is advisable and safer but of course less profitable. Having a high leverage available is a tool that has its place and an example when high leverage can be put to good use is for trading large lot sizes in the short-term when the volatility is low.