In this Forex for Beginners guide we are going to introduce some basic principles which explain how price movements and position sizes are measured in Forex. We will also highlight links to other sections of Forex Firefly which cover each principle in more detail. It is important to have a good understanding of these concepts before you begin trading so that you know exactly what you are buying or selling, and what your profit or loss will be once a trade is taken.
Additional beginners material such as quote reading and currency pairs are covered in other articles on this site, these can be found at ‘Forex trading Basics’ and ‘Introduction to Forex’.
Pips
Forex beginners can sometimes be confused by the idea of ‘Pips’, which are used to measure currency pair price movements, or the changes in price between two currencies. The word ‘Pip’ is an abbreviation of Percentage Interest Point. While you are trying to learn Forex trading you will see that pips are used continuously. A pip represents a change in the last number of a Forex quote. As we are writing, the current price of the EUR/USD is 1.3691. A one pip increase in price would take it to 1.3692, whereas a one pip decrease would drop the price to 1.3690.
Traditionally, most brokers will quote prices to four decimal places as shown above, except for currency pairs containing the Japanese Yen where only two decimal places are used. As you learn to trade Forex you will see that recently it has become common for brokers to start quoting to five decimal places, and three for pairs containing the Yen. This is called Fractional Pip Pricing. With a broker using fractional pips, the EUR/USD quote above would have an additional digit at the end. Our broker’s price was 1.36916. In this case you just need to remember that a single pip increase or decrease would result in a change to the digit one from the end. For example, 1.36926 or 1.36906. For more in-depth examples of pip calculations, read our Forex trading for beginners tutorial focusing specifically on pips. This will also cover how to calculate the value of single Forex pips for each currency.
Lots
‘Lots’ are standardised amounts of a currency and are used to let your broker know how much you want to buy or sell when placing trades. One full lot is made up of 100,000 units. This is also called a standard lot. There are also other smaller lot sizes shown below which many brokers will allow you to use. These are great for the retail trader who cannot afford to trade standard lots to begin with.
- Standard lot – 100,000 units
- Mini lot – 10,000 units
- Micro lot – 1000 units
You may be thinking that the above lot sizes look rather large. We know that trades are measured in pips, which represent very small changes in currency prices. In order to really take advantage of these small movements, a trader will need to be in control of large sums of currency, otherwise pip movements will represent such small losses or gains that it will not be worth trading. In our Forex for beginners section you can find further details about Forex lots and how they are related to pip values when making trades of different sizes.
If after looking at lot sizes you feel that they are too large and you will not be able to afford to trade, do not worry. This is where leverage comes into play.
Leverage
Understanding the concept of leverage is an extremely important part of learning Forex trading for beginners. Leverage basically allows you to move large volumes of currency using only a small amount of your own money. So, how exactly does this work?
If you wanted to trade with $200,000 then using leverage your broker will lend you the vast majority of this amount. If for example the leverage on your account is 100:1, this means that you only need to put up 1% of any amount you want to trade with, the rest is borrowed from your broker. When you make a trade your broker will put aside $2000 from your account, this will be your own contribution to the $200,000 and is known as the ‘margin’. Even if your total trading account actually contains $15,000 you are still only required to put up 1% of your position size if you have an account with 100:1 leverage.
In short, that is how the basics of leverage work. You can read more about the subject in our Forex Leverage guide to currency trading for beginners.
