Forex Pips - Why You Must Understand Them



Posted: Sunday, August 23, 2009

by Margaret Tye

Many newcomers to the Forex market begin trading without fully understanding the importance of Forex pips. Lack of knowledge is one of the quickest way to lose money when trading currency. A pip is the smallest unit of price when trading a foreign currency. It equals 0.0001 ( 4 decimal points), giving a pip value of $10 on a lot of $100,000. If the market fluctuates widely, this can mean a large profit or loss. The Japanese yen is traded to 2 decimal points 0.01, and this should be remembered if trading the yen. Traditionally prices have been quoted out to 4 decimal points, but many electronic platforms now quote to 5 decimal points, the last point being a fractional pip.

As well as the risk of losing money, understanding Forex pips is also essential in the actual process of buying and selling currency. Small traders use a broker to implement their trade. Unlike the stock market, most brokers do not charge a commission, instead there is a difference, known as the spread, between the buying and selling price measured by pips. For example, when buying dollars using Swiss francs USD/CHF 1.6250/1.6253, the difference of 3 pips is the broker's profit. It is necessary for the currency to rise by the difference between the initial buying and selling price before any profit can be made when selling again. If a currency is particularly active, the broker may only quote a difference of 2-3 pips between the buying and selling price, However if there is little demand for a currency, the gap may be considerably wider and it will be harder to make a profit. New traders should always confirm a broker's policy regarding spread before starting to trade.

In order to minimize the risk of a loss, new traders should act cautiously before committing large sums of money. They should practise for several months on the dummy trading platforms provided by most good Forex brokers and if possible take a course on trading. There are a number of courses available online. Forex pips can be confusing and it is easy to make an expensive mistake. When ready to trade, newcomers can open one of the mini Forex accounts offered by many brokers, which can be started for as little as $200.

Finally Forex trading is a high risk investment and not everyone is suited. This article is for information only and the author accepts no liability for the accuracy or for any action taken.

Margaret Tye runs the http://www.forex-trading-articles.com/what-does-pip-mean-in-forex-trading.html website.

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