Before you make the first move of registering an account with a Forex Broker, you must first understand what some Forex Terms mean. You’ll find these terms either on the Broker’s website or on the Mt4 Platform. If you do not know what they mean you will be confused on how to go around making the perfect deal.

  • Pip
  • Spread
  • Lot
  • Leverage

 

Pip

A pip is a term used to describe the smallest amount by which a currency quote can change. In other words, it is a standardized unit or measure of change in a currency in the Foreign exchange market. Let us use the EUR/USD quote as an example. Assuming the price quote for EURUSD is 1.1086, and the price increased to 1.1087, the change is by a pip movement (1 pip).

Actually, a pip must have a value. When dealing with the EURUSD, the pip value is determined by the amount of Euros bought. If the amount of Euro purchased with USD is 10,000Euro, the amount paid will be $9,020.40 ([1/1.1086] x 10,000). If the price quote increases by 1 pip to 1.1087, the amount spent to buy 10,000 Euro will be $9,019.60 ([1/1.1087] x 10,000). The value of the 1 pip change would then be $0.80 ($9,020.40 – $9,019.60).

Many Forex brokers offer Forex calculators to help you find the value of a pip by entering the variables so that you don’t crack up your brain.

 

Spread

From Lesson Three you read how currency pairs are quoted, and you read about the Bid and Ask Price. Prices in Forex are represented as currency pairs or exchange rate quotes where the relative value of one currency unit is denominated in another currency. In every currency pair price quotation, there are the Bid and Ask Price. The difference between the Ask and Bid Price is called the SPREAD. This is as simple as the meaning of Spread can be.

If the price quote for EURUSD is 1.1084/1.1086, then spread is

1.1086 – 1.1084 = 0.0002 (2pip Spread)

 

Lot

The amount or volume of currencies you buy or sell are measured in Lots. We have the Standard Lots = 100,000 units

Micro Lots = 10,000 units

Mini Lots = 1,000 units.

The Lot size or Volume of trade affects the value of pip. So, the value of a pip movement depends on the Lot size of the currency traded.

 

Leverage

You have learned in Lesson Four that you must open a margin account with a Forex Broker before you can buy/sell currencies. The next step would be to deposit money into your margin account with the broker. How would you feel if the Broker Loans you money to add to your capital in order for you to buy more than what your initial capital could afford? Happy!!

Leverage is a loan provided to you by your broker. The amount of Leverage or Loan can be measured in ratio. It is either 50:1, 100:1 or 500:1. The amount of loan your broker is willing to give you would depend on the size of your trade and what is being traded. If you are buying up to 1 standard Lot (100,000unit), your broker could give you leverage up to 100:1. The higher your trade volume the lower the leverage would be. However, Forex brokers do not regulate how you use the loan given to you. They will make available 1:1 to 1:500 and you can choose how much Loan you want to accept and add to your trade at your own risk.

How does Leverage help you actually?

Let’s say you want to trade 1 standard lot of USD/CHF, you’ll need $1000 for this without Leverage. If you apply a leverage of 100:1 to this trade, you will only need $100 (100,000/1000) to complete your transaction. You have used only 1% of your $1000 margin account. The exchange rate of a currency pair will determine the margin required to open a 1 Standard Lot trade. If you apply 50:1 to your trade, you’ll need 2% of your initial capital to make a 1 Standard Lot Trade. The higher the leverage the lower the margin required to make a purchase.