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Pips, Spread and Margin

What is a Pip?

The digits after the decimal point are called pips (“price interest points”) and they measure the change in the exchange rate for a particular currency pair. To be exact, 1 pip is the difference in price of a one thousandth in any currency pair.

For example in the EUR/USD pair 1 pip stands as the change in price from 1.18000 to 1.18010, the price has moved by 1 ten thousandth or else 1 pip.

So we have established that 1 pip is the change in the currency’s price by 1 unit at the fourth decimal point – and it reflects a change in price of 1/10,000. As such, if the price moves from 1.18000 to 1.18050 then this is a price change of 5 pips, from 1.18000 to 1.18200 it’s 20 pips and so forth.

The common exception here are currencies trading against the Japanese Yen, where a pip is 2 decimal places or 1/100. For example in USD/JPY pair if the price moves from 110.000 to 110.010 that would be a one point move.

So why are there 5 decimal points?

ADS Prime quotes Forex prices to the fifth decimal place – for example 1.18001 – for most pairs except for some like the pairs including the Yen where the pricing comes with 3 decimal points – for example 110.001 – as this is market practice when trading FX.

As such, the smallest possible change is smaller than 1 pip since we’re quoting prices in 5 decimals – or three for Yen pairs.

For example, the EUR/USD currency can move from 1.18000 to 1.18003. This is a change of 0.3 pips which we simply call “fractional pips”. We make this clarification because FX rates on websites, guides or analyses are often mentioned with 4 decimal points – or 2 for Yen – which is done for simplicity.

Pip value

The value of a pip is dependent on the currency pair being traded, the size of the trade, and the exchange rate. It is simple to understand that the change in price for the EUR/USD from 1.1800 to 1.1810 reflects differently when we’re “exchanging” 1,000 Euros or 10,000 Euros. In the first case we would receive 1,180 or 1,181 Dollars dependent on the rate while in the second we would receive 11, 800 or 11, 810 Dollars. As such the “value” of 1 pip in real money is closely tied to the amount of money we’re exchanging or else the “trade size”.

Spread

The difference between a bid and offer price is called a spread. This is simply the difference between the best price that you can currently buy or sell a given currency pair at that current point in time.

So in the example of EUR/USD1.18000/1.18007 the spread is 0.7 pips.

Forex position sizing

FX trades are often traded in lots to make is easier to match buyers and sellers “orders” or position sizes. If someone wanted to buy 1,231 Euros against the Dollar it would require someone willing to make the exact opposite transaction. To avoid some complexities we package transactions sizes in standardized amounts and we call them “lots”.

ADS Prime offers lot sizes of:

  • 1 lot = 100,000 of the first named currency in the pair
  • 1 mini lot = 10th of a lot or 10,000 of the first named currency in the pair
  • 1 micro lot = 100th of a lot or 1,000 of the first named currency in the pair

Margin or leverage

Margin, or leverage, means that you only need to hold a proportion of your overall exposure to the market when you open a trade. For example you might buy $1,000,000 against the Australian Dollar without requiring this full amount on your trading account. Instead you are required to put down a percentage of this amount, a percentage dictated by the leverage or margin settings of your trading account.

For example, a margin rate of 1% would mean that you would need to deposit only $10,000 in order to hold a positions of $1,000,000; your deposit of $10,000 is ‘leveraged’ to allow you trade in much larger size.

Similarly if the leverage was higher at 1:500, or 0.2% margin of the position value, it would mean that the same $10,000 would allow you to open a position up to $5,000,000. Margin is a double-edged sword; while it can result in significantly larger gains if the market moves in your favor, if it moves against you it can increase your potential losses accordingly.

How margin works

An investor deposits $100,000 in his ADS Prime account. The account is set to 1% margin or 100:1 Leverage. What this means is that for any position he opens he must maintain a 1% margin.
If he wishes to open a position of $1,000,000 then he must put aside 1% or $10,000 in Margin ($1,000,000×1%=$10,000) from his account balance. Essentially the remaining $990,000 is being borrowed from ADS Securities for the duration of the trade.
This margin amount remains “reserved” in his account while the trade is open – this means that he now has the rest of his account balance – $90,000 – available to enter other trades.
The money on a trading account not allocated to margin covering positions currently open on the account can be used to open other trades, increasing the total exposure, or to cover adverse moves in the market price of the open positions.


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