How To Calculate Pips and Lot Size In Forex

Introduction.

Forex trading can seem like a daunting world to jump into, especially when it comes to understanding key concepts like “pips” and “lot size.”

But don’t worry – once you get the hang of it, these terms are pretty straightforward and crucial for making sense of your trades.

Whether you’re looking to get into trading for the first time or fine-tune your skills, understanding how to calculate pips and lot sizes is a must. It’s like learning the basics of any skill – once you know these two, everything else falls into place a little easier.

In this article, I’m going to break down both concepts and show you how to calculate them, step by step.

I’ll also give you some real-world examples so you can see how these numbers actually work when you’re trading. Let’s dive right in!

What is a Pip?

Before we get into the math behind calculating pips, it’s important to know what a pip is. In the simplest terms, a pip is the smallest unit of price movement in the forex market.

When you’re trading currency pairs, the price of the pair moves up and down in small increments. Each of these small movements is measured in pips.

For most currency pairs, one pip equals 0.0001. So, if the EUR/USD pair moves from 1.1050 to 1.1051, it has moved 1 pip.

There are exceptions to this rule, though. For example, if you’re trading currency pairs that involve the Japanese yen (like USD/JPY), a pip is equal to 0.01. This means that a move from 109.10 to 109.11 would be one pip in this case.

Why is this important? Pips help traders measure the price movement of currency pairs and calculate how much profit or loss they’re making. It’s a simple yet powerful way to understand how much money you’re gaining or losing with each trade.

How Do I Calculate Pips?

Now that we know what pips are, let’s talk about how to calculate them. The formula is pretty simple once you get the hang of it. Here’s how you can calculate pips in two common types of currency pairs.

1. Currency Pairs That Don’t Involve the Japanese Yen (like EUR/USD)

For pairs like EUR/USD, GBP/USD, or AUD/USD, the formula to calculate pips is:

Pip Value = (0.0001 / Exchange Rate) * Trade Size

Let’s say you’re trading EUR/USD, and the current price is 1.1050. If the price moves from 1.1050 to 1.1051, that’s a 1-pip movement. To figure out the value of that pip, you would use the formula above.

For example, if you’re trading 10,000 units (which is a micro lot), you would calculate it like this:

• Pip Value = (0.0001 / 1.1050) * 10,000
• Pip Value = 0.00905 USD per pip

So, for each pip move, you’d make or lose about 0.00905 USD per micro lot you’re trading. If you were trading a larger position (like a standard lot of 100,000 units), the pip value would increase.

2. Currency Pairs Involving the Japanese Yen (like USD/JPY)

For pairs like USD/JPY, the pip calculation is slightly different because, as mentioned earlier, a pip is equal to 0.01 instead of 0.0001. The formula here is:

Pip Value = (0.01 / Exchange Rate) * Trade Size

So, if the USD/JPY pair moves from 109.10 to 109.11, that’s a 1-pip move. Using the same example with 10,000 units (micro lot):

• Pip Value = (0.01 / 109.10) * 10,000
• Pip Value = 0.00917 JPY per pip

And the same principle applies for larger lots – the pip value increases based on the size of the trade.

What Is Lot Size and Why Does It Matter?

Now, let’s talk about lot size. In forex, a “lot” refers to the size of your trade or the amount of currency you’re buying or selling. There are a few different types of lots:

• Standard Lot: 100,000 units of the base currency (this is the currency before the slash in a currency pair – for example, EUR in EUR/USD)
• Mini Lot: 10,000 units of the base currency
• Micro Lot: 1,000 units of the base currency
• Nano Lot: 100 units of the base currency

Lot size matters because it determines the value of each pip. The bigger the lot size, the more each pip is worth. For example, if you’re trading a standard lot (100,000 units), each pip will be worth $10 (for pairs that don’t involve the yen). If you’re trading a micro lot (1,000 units), each pip will be worth about $0.10.

It’s important to understand how lot size works, because it directly affects your potential profits or losses. Trading larger lot sizes can lead to higher profits, but it also increases the risk.

How Do I Calculate Lot Size?

To calculate lot size, you need to know the amount of risk you’re willing to take on a trade. Let’s say you’re risking 2% of your account balance per trade. You also need to know how much you’re willing to risk in terms of pips.

Here’s a simple formula for calculating lot size:

Lot Size = (Account Equity * Percentage of Risk) / (Stop Loss in Pips * Pip Value)

For example, if you have a $10,000 account, and you’re willing to risk 2% on a trade with a stop loss of 50 pips, you can calculate your lot size like this:

• Lot Size = (10,000 * 0.02) / (50 * 0.0001)
• Lot Size = 200 / 0.005
• Lot Size = 40,000 units (or 0.4 standard lots)

So in this example, you would be trading 0.4 standard lots, which would give you the risk exposure you’re comfortable with based on your stop loss and account balance.

Putting It All Together: Example of a Trade

Let’s walk through an example to put everything together:

Imagine you’re trading the EUR/USD pair. The price is 1.1050, and you decide to enter a trade when the price moves to 1.1055, a 5-pip increase. Let’s say you’re trading a mini lot (10,000 units).

• Pip value = (0.0001 / 1.1050) * 10,000 = 0.00905 USD per pip
• For a 5-pip movement, your profit = 0.00905 * 5 = 0.04525 USD

If the price moves in your favor, that’s how much you’d make for that move.

If you had traded a standard lot (100,000 units), the pip value would be 0.0905 USD per pip, and your profit would be 0.45 USD for the same 5-pip move.

FAQs

1. What’s the difference between a pip and a point?

A pip refers to the smallest price movement in a forex pair. A point is just another term sometimes used interchangeably with pip, but it often refers to the smallest change in a price, which could be a fraction of a pip (like 0.00001 in most pairs).

2. How can I calculate pips for a trade that involves the Japanese yen?

For yen pairs, a pip is equal to 0.01, not 0.0001. Use the same formulas, but remember the pip value calculation changes for yen pairs.

3. What is a lot size and how does it impact my trade?

Lot size refers to the number of units of currency you are buying or selling in a trade. The larger your lot size, the more each pip is worth, which affects your profits or losses.

Conclusion

Calculating pips and lot size is essential to understanding forex trading and making smart decisions about risk and reward. It’s one of the first things you’ll learn, but mastering it can boost your confidence in managing trades effectively.

So, now that you know the basics of calculating pips and lot size, how will you apply this knowledge to your next trade?

Will you start with smaller lot sizes to minimize risk, or dive in with larger ones to go for bigger rewards?