Understanding forex terminology is a crucial aspect of becoming a wealthy trader, and although there are lot of terms to learn, each one plays an important role in your success. As a trader you're likely to encounter the word 'PIP' everyday because of its importance in the currency market, and it may be one of the most important terms to understand because of its role in calculating losses and profits on a daily basis. A PIP (Percentage in Point), also referred to as simply a 'point', is the smallest increment of measurement used in a specific currency. In simpler terms, a single PIP is the smallest amount that a currency can change in value.
The Value of a Single PIP
For the majority of currencies, (with the exception the Japanese Yen) a PIP is 0.0001 (one one-hundredth of a cent). To the average person this may seem to be of extremely trivial and minute value, however considering that many currencies are traded in lots of $100,000, a single PIP can amount to $10 (or in a million dollar lot, a PIP would be $100 etc). Thus if you are, for example, trading in lots of $100,000, when the value of a currency rises just 4 pips this equates to a potential profit of $40. If a similar occurrence happens every day you would generate a minimum of $1200 profit that month on a particular currency. Although most successful traders earn much more, this example accurately and simply illustrates the importance of a single PIP, even though it is the smallest fluctuation in forex rates. Note: When currencies are compared to the Japanese Yen a PIP is 0.01 or 1 cent, thus if a trader is trading to the Japanese Yen in lots of $100,000 a PIP would equate to $1000.
Understanding Forex Lots
In forex terms, a 'lot' is the minimal amount to be traded in a currency transaction. For conventional trading accounts on commonly used trading platforms, a lot is equal to one hundred thousand units of the base currency, however there are also miniature accounts as well that allow for smaller lots. Your choice in lot size should depend on your investment capabilities as a trader, as well as the individual risk of the particular trade you are about to engage in.
Understanding PIP Spreads
The PIP spread plays an important role in forex terminology as well. It is the difference between the selling and buying price of a currency pair. Thus, if the EUR/USD pair is quoted at 1.4703 bid and 1.4707 ask, then the spread would be 3 PIPs. In basic terms, the spread is the amount you have to invest initially, so in the aforementioned example you would be taking a loss of 4 PIPs at the beginning of the trade. Thus, the forex contract must appreciate by at least 4 PIPs before the investment proves to be lucrative. Therefore, the lower the PIP spread, the easier it is to earn a profit. In active and larger markets the PIP spread will tend to be lower, whereas more inactive markets will have higher and riskier spreads.
Learning the various aspects of PIPs and how they fluctuate during trades is an important part of becoming a successful trader. Using the above information you should be able to start your journey in becoming experienced with crucial forex terminology.