Understanding Pips



Posted: Tuesday, March 17, 2009

by Margaret Tye

Many people who want to trade on the Forex market are nervous to try because they don't fully understand pips but realise that making a mistake in their calculations could cost a considerable amount of money.

Trading on the Forex market is similar to buying stocks and shares except that instead of paying a broker's commission there is a difference in the selling and buying price of currency and this spread, measured in pips, must be taken into account when calculating profit or loss.

A pip is the smallest unit of price when trading a currency. Most currencies, apart from the Japanese yen, are trading to 4 decimal points, 0.0001. Although this may seem a small amount, with a standard lot of 100.000 units of the base currency, a market movement of several pips up or down can equal significant profit or loss. The Japanese yen is traded to 2 decimal points.

Although a wide fluctuation in the price of a currency can result in huge losses or gains, and is a tremendous gamble for the small investor, many Forex brokers offer mini Forex accounts where it is possible to start trading currencies with a few hundred dollars.

When you buy a currency you are also be selling another. You are betting that the currency you are buying will increase in value, but the currency must first increase by the spread difference just to break even, therefore it is important to get the lowest spread you can find, while always dealing with a reputable broker. The more active the two currencies you are dealing in, the smaller the spread between the buying and selling price is likely to be, it can be as low as 2-3 pips. The spread difference is something you need to clarify with the broker that you are dealing with to make sure that the spread on offer does not fluctuate according to market circumstances.

Many Forex brokers offer dummy trading platforms to allow you to practise trading. No one should consider trading on the Forex market unless they have spent several months practising and even then they should never invest more than they can afford to lose. A dummy trading platform and the real market are two very different experiences. Trading on the Forex market is a high risk investment and more people lose money than make a profit. For every currency trade someone has to be a loser and the small investor is competing against the big institutions.

This article is for information only. Forex trading is a high risk investment and the author accepts no liability for any action taken.

Margaret Tye runs the Forex Trading Articles website. For more information please visit the pips page.

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