Forex contracts are traded in increments of pips or fractions of pips, depending on the broker and the currency pair being traded. This article will explain what pips and fractions of pips are, how they are used in forex trading, and the advantages and disadvantages of trading in pips or fractions of pips.
What are pips and fractions of pips?
Pips, or “percentage in point”, are the smallest unit of measurement in forex trading. They represent the fourth decimal place in most currency pairs, except for pairs that involve the Japanese yen, which have two decimal places. For example, if the EUR/USD currency pair is trading at 1.1255, a one-pip movement would be from 1.1255 to 1.1256. This movement represents a change of 0.0001 in the exchange rate.
Fractions of pips, also known as “pipettes”, are used by some brokers to provide more precise pricing. They represent the fifth decimal place in most currency pairs, except for JPY pairs. For example, if the EUR/USD currency pair is trading at 1.12552, a one-pipette movement would be from 1.12552 to 1.12553. This movement represents a change of 0.00001 in the exchange rate.
How are pips and fractions of pips used in forex trading?
Pips and fractions of pips are used to calculate the profit or loss on a forex trade. When a trader buys a currency pair, they will look to sell it at a higher exchange rate to make a profit. When they sell a currency pair, they will look to buy it back at a lower exchange rate to make a profit.
For example, if a trader buys the EUR/USD currency pair at 1.1255 and sells it at 1.1265, they have made a profit of 10 pips. If they had traded with a standard lot size of 100,000 units, the profit would be $100 ($10 per pip). If they had traded with a mini lot size of 10,000 units, the profit would be $10 ($1 per pip).
Advantages and disadvantages of trading in pips or fractions of pips
Trading in pips or fractions of pips has its advantages and disadvantages. The main advantage is that it provides a clear and concise way to calculate profits and losses. Traders can easily see how much they are making or losing on a trade, which helps them to manage their risk and make informed trading decisions.
Another advantage is that trading in pips or fractions of pips allows traders to use leverage to increase their potential profits. As mentioned earlier, a standard lot size of 100,000 units can result in a profit of $10 per pip. This means that even a small movement in the exchange rate can result in a significant profit when using leverage.
However, trading in pips or fractions of pips also has its disadvantages. One disadvantage is that it can be confusing for beginners who are not familiar with the terminology. It can take some time to understand how pips and fractions of pips are used in forex trading, and how they affect the profit or loss on a trade.
Another disadvantage is that trading in pips or fractions of pips can be risky, especially when using leverage. A small movement in the exchange rate can result in a large profit or loss, depending on the lot size and the amount of leverage used. This means that traders need to be careful when using leverage and make sure to use proper risk management techniques.
Conclusion
In conclusion, forex contracts are traded in increments of pips or fractions of pips, depending on the broker and the currency pair being traded. Pips and fractions of pips are used to calculate the profit or loss on a forex trade, and they provide a clear and concise way to manage risk and make informed trading decisions. While trading in pips or fractions of pips has its advantages and disadvantages, it is an essential part of forex trading that traders need to understand to be successful in the market.
