Even though the Forex market shares many common characteristics with other investment options, it is very different in the mechanics used to make your trades. Two of these unique aspects are the concepts of Pips and Lots. Understanding what these terms mean and how to use them properly will allow you to maximize your earnings in the Forex market.
Pips and Lots are two terms that most new Forex investors may not completely understand and only know that they influence the way they trade and their earnings. Simply put, both of these terms are used as a unit of measure for trading that will help define how a broker makes your trades and what type of profit you can expect from your investment.
Pips Determine Your Profit
A pip is the smallest measure of movement in the value of a currency and determines your profit on a particular trade. This pip value can vary between brokers so it’s always a good idea to understand how broker you’re using to trade defines this value. Most larger brokers base the movement of a currency pair on a full pip but may also offer fractional pips as well to some of their clients. These pips represent a small increase or decrease in the value of a currency, which will vary depending on the pair you are trading. For example, if you are trading the USD/JPY currency pair, each pip of movement is equal to .01 cents in value. Other currency pairs like the GPB/USD use a .0001 value for defining the pip and the movement of the currency value will be need to be much larger to generate a similar profit.
For newer traders it is easier to calculate the success of their trading strategies based on their pip gains alone. This gives these traders a clear indication of how well a particular strategy is working for them over time without the work of converting the various pip values into real dollars.
Lots Define Your Minimum Investment
A lot is defined as the smallest group of currency pairs you can trade with a broker. This value varies with the currency pair you are trading as well as the broker you are using to make your trades. For example, many larger brokers set the lot size for trading USD-based pairs at 100,000. This means any time you trade against this currency, the smallest investment you can make from your account is 100K.
In recent years brokers have established more flexible accounts for smaller traders that have reduced lot requirements. These Mini and Micro accounts feature a smaller opening balance and equity than a full account but also allow a Forex trader to make smaller investments. With these newer accounts, most brokers now offer lot sizes of 10,000 units of the base currency for Mini accounts and 1,000 units of the base currency for Micro accounts. These smaller lot sizes enable new Forex investors to trade in the market without the worry of having to make the larger 100K investment. While these smaller accounts typically offer a lower leverage value than a full account, they allow investors to still reap the profits from a wise trade.
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