How do you keep score in forex? Is it through the profits? The rate of return? The number of winning trades?
Well, it's none of that.
The scorecard for forex trading is measured in pips.
Experienced forex traders keep tally in pips because it's a more unadulterated measure of successful trades than other criteria.
As a new trader, knowing what pips are and how you can calculate pip value is critical.
By reading this article, you will learn some formulas for you to set risk through pips, calibrate your position size, and convert pips earned back to your account currency.
Percentage in point or pips begins at the fourth decimal place in a currency pair.
So, if the exchange rate for the GBP/USD an hour ago was 1.2800, and it's now at 1.2830, this means the GBP/USD increased by 30 pips (1.2830-1.2800 = 0.0030).
Conversely, if the rate for GBP/USD was 1.2800 and fell to 1.2770 after an hour, that's a 30 pip decrease (1.2770-1.2800= -0.0030).
Calculating the Pips' Value
To appreciate the importance of pips in a trade, you need to know the value the pips represent. The calculation is simple: just multiply one pip to the contract size then to the number of pips.
0.0001 x (lot size) x # of pips
So, for the GBP/USD example, multiply 0.0001(which represents one pip) to the contract size you subscribed to, say, a mini lot, which is 10,000 units.
That's equal to $1.
After that, multiply $1 to the number of pips, which in the example is 30 pips, and that's equal to $30.
Or, get the difference between two prices and multiply it directly to the contract size: 0.0030 x lot size.
Just keep in mind that you need to omit negative values when doing this.
Therefore, in the two scenarios, it's either a $30 profit or a $30 loss.
Converting Pip Value to Your Account's Currency
Now, the pip value formula above is only applicable if your trading account is in US dollars.
What if it's in Euros?
Well, to convert pip value to your account's currency, you first have to look for the exchange rate of the quote currency to the currency in which your account is denominated.
For instance, if your account is in Euros and the currency pair you wish to trade is the GBP/USD, you have to refer to the exchange rate of the EUR/USD.
Since the pips' value is in USD, the next step is to divide that to the EUR/USD exchange rate to get the value in Euros.
If the exchange rate for the EUR/USD is 1.1235, then you divide $30 to 1.1235, and that's equal to €26.70. So, instead of a $30 pip value, you get €26.70.
Converting pip value of a cross currency pair to your account's currency
If you're trading a cross currency pair or a currency pair that doesn't include the US dollar and want to convert its pip value to USD, all you have to do is multiply the pip value to the exchange rate of the dollar pair of cross currency's base currency.
Example: You are trading the EURGBP at £1 per pip. To get the dollar equivalent, multiply £1 to the current exchange rate of the GBP/USD.
Among the eight major currencies, the Japanese Yen is the only currency where the pip counting starts at the second decimal place.
The reason for this is the value of the Japanese Yen relative to others is significantly lower, but the same formula for calculating pip value applies.
(One pip (0.01) x contract size x # of pips.)
Setting Risk Through Pips
Most experts advise setting a 1% risk per trade, and here's how to do it.
First, multiply the 1% risk to the funds you have in your trading account.
If your account is $2000, then the answer is $20 ($2000 x 1% = $20).
Next, you have to know how many pips you'd risk losing in the set up you're eyeing on.
For example, your technical strategy permits you to lose 50 pips.
Then, you have to divide the number of pips to the dollar risk, so $20 ÷ 50 pips = 0.4.
That 0.4 is actually $0.40, which represents the pip value you should have so that when your trade does go the opposite way -- 50 pips away from the price you initiated the trade -- you'd only risk losing $20.
The last step is to select the lot size that you will use that equates to a $0.40/pip value.
To get the lot size, divide $0.40 to 0.0001, and you get 4,000 units or 4 micro lots.
That means if you trade with 4 micro lots and with a preset risk of 50 pips, your potential loss would only be 1% of your $2,000 account, which is $20.
Remember: If you are trading a currency pair that doesn't include your account currency, you have to convert because the example above is only for a dollar-denominated trading account.
Quiz and Calculator
Here's a problem for you to solve:
Your account is $5,000, and you have a trade set up that allows you to lose 50 pips, and your risk per trade is 0.5% of your account.
What lot size do you need to use, and what is the value of each pip?
Position Size Calculator
To make it easier for you, here is an excel sheet that you can download to calculate position size. All you have to do is enter your account size, percentage of risk per trade, and the number of pips you will be risking, and it will calculate the lot size you need as well as the pip value.
Download Our FREE POSITION SIZE CALCULATOR
You will be redirected to sign up page where you can download the Excel file.
Mastering these formulas requires you to apply them in your trading continually, and it's helpful to do that on a demo account first.
Once you are exposed to these calculations on a regular basis, you will find it second nature to manipulate them in your head.
But since all of these are mostly calculated automatically on your trading platform, the one key takeaway that will come in handy at all times is position sizing because it allows you to limit trades within a specific percentage of risk.
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