What are pips, pip value, and spread in Forex margin trading?

This article will help you understand the important terms in Forex margin trading: Pips, Pip Value, and Spread. Mastering these terms can assist you in calculating profits and understanding the significance of these values.

In the forex market, the main activity of traders is to simultaneously buy one currency and sell another, profiting from the value difference and interest rate differential between the two currencies.

There are mainly four types of Forex trading, including Forex cash, spot trading, futures, and margin trading. Among these, Forex margin trading is the most common, so when people talk about Forex trading, they usually refer to Forex margin trading.

In the field of Forex trading, there are many professional terms, such as Pips, Pip value, and Spread. Next, we will explain the meanings of these Forex terms in detail:

What is a Pip?

Pip refers to the point movement value (percentage in point), which is the unit of change in foreign exchange rates and is also the most commonly used pricing unit in forex trading.

In most Forex trades, whether it's EUR/USD, GBP/USD, etc., the fourth decimal place is 1 pip, while for USD/JPY, the second decimal place is considered 1 pip.

For example, when the price of EUR/USD changes from 1.07370 to 1.07381, the difference is 0.00011, which means it is a difference of 1.1 pips.

The aforementioned change of 1.1 pips in value for investors' profit and loss is determined by the contract specifications and the number of contracts traded, which is the meaning of Pip value. Next, we will further introduce this concept.

What is Pip value?

Pip value refers to the price of one pip, which is determined by the contract size and quantity traded by the investor.

Formula: Pip value = Pips * Contract size * Contract quantity

Forex trading is conducted in the form of contracts, which is similar to futures trading, but in futures trading, contracts are represented by "contracts," while in Forex trading, we use "lots" to represent them.

In a typical forex contract, a standard contract is 1 lot, and a mini contract is 0.1 lot; 1 lot represents 100,000 currency units, while 0.1 lot represents 10,000 currency units. This is the scale difference between mini contracts and standard contracts, which is 10 times.

Standard Contract

1 lot = 100,000 currency units

Each change of 1 pip = 10 currency units (0.0001 * 100,000 = 10)

Mini Contract

0.1 lots = 10,000 currency units

Each change of 1 pip = 1 currency unit (0.0001 * 10,000 = 1)

For example, with EUR/USD:

If you trade 1 lot of EUR/USD, then the pip value is 0.0001 x 100,000 = 10 USD, which means that for every 1 pip movement in the EUR/USD price, the investor will gain or lose 10 USD.

Therefore, if trading 2 lots of EUR/USD, the pip value would be 20 USD, meaning that for every 1 pip movement in the EUR/USD price, the investor would gain or lose 20 USD, which also illustrates how the number of contracts affects the size of the pip value.

If the opening price of EUR/USD is 1.16010 and it is sold at a price of 1.16945, then a profit of 93.5 pips will be made.

Therefore, the profit and loss of one Standard Contract = 0.00935 * 100,000 (contract size) = 935 USD.

What is Spread?

Whether exchanging currency at a bank or trading on a Forex trading platform, there will be two types of quotes for currency exchange.

One is the selling price, which is the seller's quote (Ask), and the other is the buying price, which is the buyer's quote (Bid). The difference between these two prices is referred to as the Spread.

Formula: Spread = Bid - Ask.

The spread between the bid price and the ask price is essentially the fee charged by banks or brokers; therefore, the spread can be considered one of the costs incurred each time a forex trade is executed.

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