This is the 3rd article of my Forex article series. If you want to read the first 2, here they are:
Here’s one thing that you really need to acknowledge, if you want to be an effective Forex trader, you need to be good at math. But don’t worry, it’s not a very complex kind of math, just a little to get you through your every trading activity. In this section, let’s get to know about the mathematical flow behind Forex trading.
The good thing about online trading brokers is that they will handle most of the mathematical stuff needed for your trading. You really don’t have to worry about calculating your stored earnings or if your earnings will be really sent to your bank account.
If you have chosen a broker that has already been around for years already and if many people are using the platform, you are in good hands. However, you really need to learn some basic Forex mathematics so you can come up with truly profitable trades.
Understanding Forex quotes
This is about exchange rates. Becoming an efficient trader means that you have to be really good at reading exchange rates and utilizing them to your advantage. Forex quotes are about the rate that you will gain or lose if you proceed with a certain trade. For instance, if the quote of the EUR/USD pair is “1.1500” it means that in order to obtain 1 Euro, you need to spend 1 dollar and 15 cents.
You have to also understand that the currency on the left, “EUR” is the base currency while the “USD” is the quote currency. So the one on the right is the one that will pay for the one that’s on the left. For every currency pair, the value of the base currency will always be “1.”
The base currency is the basis of the act of buy and sell. So if you are buying the EUR/USD pair, it actually means that you are buying the Euro and selling the Dollar at the same time. Conversely, if you are selling the EUR/USD pair, it means that you are selling the Euro while buying the USD.
In every trading act, you really need to be watchful with currencies that might go down or those that might go up. So if a certain currency appears like it’s going up, you might want to sell it. If it appears to go down, you have to consider buying it.
About pips
Pips are defined as the rate at which currency prices are moving within the Forex market. Pips can be identified as the fourth number of the decimal value of a quote. For instance, if the EUR/USD quote rises from “1.1500 to 1.1501,” it means that the pair has an increase of 1 pip. And if it becomes “1.1499,” it means it is down by 1 pip as well. Reading pips in that manner works when dealing with all the major currencies, except for the Japanese Yen which is only read up to the second decimal place.
Calculating pips is an important task for a Forex trader because it can allow you to manage your profits and losses effectively. For instance, if you’re buying the EUR/USD pair with a pip of 1.1520, it means you will earn that an exact amount of 1 dollar and 15.20 cents. If for instance, the pip is down to 1.1480, it means that you’ll lose with that rate. The simplest way to understand it is, if the pips are up, you will gain, but if the pips are down, you will lose.
About spreads
This can be simply defined as the difference between the buying price and the selling price. Another way to view spreads is that it is the payment you’ll give to the brokers. If you’ve already visited some money-changing establishments, you would have probably noticed that you’re given 2 prices.
If you are living in a country with a different currency like in Asia, you can easily see that buying a USD would expensive. However, if you are from the US and you are exchanging your Dollars with an Asian currency, you will gain a lot since your currency is one of the dominant currencies in the world.
To understand it further, let’s say that in the EUR/USD pair, the selling price is “1.1511” and the buying price is “1.1513,” the difference is clearly 2 pips. It means that the transaction cost, or the amount that you’ll pay to the brokers will be 2 pips. So for any trading, you’ll do, once you click the buy button for the EUR/USD, you will need to pay 2 pips to proceed with the transaction.
While looking at the interface of your broker’s platform, you must not be surprised if you are given a number with 5 decimal places although we have already discussed that they are only 4 decimals. For instance, you might see that instead of seeing just 1.1513, you might actually see “1.15136 The fifth one which looks like an exponent in Algebra is called a “Pippet.”
To make it easier for you, just ignore the fifth number. You just have to focus on the fourth decimal number since it is where the true Pips are counted. But in case you want to include that exponent, the actual size of your Pip would be 1.8 Pips.
Volumes and lots sizes
Since Pips are dependent on the prices of your chosen currencies, how big or small they are will be dependent on the amount that you will choose to spend. If you open a trade in your broker’s platform, you will be prompted to enter the volumes that you want to input. Such a number will determine the exact size of the Pips.
To execute the ideal sizes of the Pips you may want to input, let’s have some benchmarks. For this, let’s get to know the lot sizes in Forex trading. They are classified as a standard lot, mini lot, and micro lot. Standard lots have 100,000 units with a volume of 1, and a value of $10 per Pip. Mini lots are 10,000 units with a volume of 0.1, and a value of $1 per Pip. Micro lots are 1,000 a volume of 0.01, and a value of $0.1 per Pip.
When trading with major pairs, or those that involve EUR or USD, the typical amount per pip would roughly be $10 per pip, if you are trading under the standard lot category. So if you gained 20 pips, your exact earnings can be calculated as 20x10 which would give you $200. You have to note however that if you lose, that will also be the amount that you’ll lose.
If you proceed with trading under the mini and micro-lots, you just have to decrease your expectation by 10% each. The higher the lot, the bigger the gains and the bigger the losses will be. If you choose the mini lot, you will be either gaining or losing $1 per Pip, which can make earn $20.
If you make it lower into 0.01, you’ll be trading with a micro lot. Now if you want to just make it half that amount, you can of course choose 0.05. You can also choose 0.03 or any other amount. The counting by 10 price allocations is just there to make it easier for you to estimate your possible gains or losses. What you need to remember is that you can always customize them according to your wishes.
When you are still a novice trader, it is highly recommended that you start with small amounts, which makes the micro lot your most likely choice. This is to ensure that you will still be interested to proceed with further trading acts if in case you will suffer some losses.
What you just have to bear in mind is that calculating your risks will always be integral to your trading endeavors. Even if you are earning small bits of income in Forex, that’s totally fine as long as you are winning consistently. If you are doing huge trades but you are experiencing huge losses too, then that can really hurt your trading journey – you have to avoid that by all means.
