Today some basic information. As I mentioned in my lecture about Forex in this market we operate mainly with foreign currencies. Especially foreign currency pairs for example EURUSD. The currency pair is closely related to exchange rate for EURUSD it is for instance  – 1.6234. To make it clear I have to add that – a currency pair is the quotation of the relative value of a currency unit against the unit of another currency in the foreign exchange market. The currency used as the reference is called the counter currency and the currency that is quoted in relation is called the base currency. Taking into consideration EURUSD it means that:

EUR – the base currency

USD – the counter currency.

1 pip – percentage in point – is the smallest quoted change of an exchange rate of a currency pair. In our example the rate changes of 0.0001 which means the change from 1.6234 to 1.6244, the price ratio increased by 10 pips. For different currency pairs the movement of the price can be different (not always fourth decimal point).

1 lot is for example 100000 of a base unit.

lewar in practice enables operations with larger amount of money we really have. The leveraged value is different and it varies from 1:10 to 1:500. It depends on the broker and the value of the order.

To make the analysis clear let us agree that we have an account in USD. Taking into consideration currency pair EURUSD the percentage in point 1 pip is 0.0001 of the price then 1 lot is 100000 of base unit.

Now a little bit more difficult mater.

Lets now combine pip and lot.
Being an investor we are interested if we are able to earn money on the movement of prices. It’s quite easy to convert from the formula:

1 pip value for 1 lot = 1 pip * number of base unit for 1 lot,

For our example - currency pair EURUSD:

The value of 1pip for 1 lot is 0.0001*100000 = $10.

You may ask why $10? Because the value is always expressed in the counter currency. Thus if the price moves by 10 pips (for example from 1.6234 to 1.6224) for the order with a value of 1 lot we will lose or earn $100.

If you want to make an order with a value of 1 lot we need to have at least 100000 base units. It’s quite difficult to make for an ordinary man. That’s why we need some help of a broker who will allow us to make an order with a value of 0.1 lot or 0.01 lot. Such accounts are often called mini or micro lot trading accounts. For example if we want to make an order with a value of 0.01 lot we need to have one hundred times less money in the account which means our gains will be one hundred times smaller.

On the one hand we have to remember that it’s not very easy to act in Forex. But on the other hand we have a very helpful tool which is called leverage. Thanks to it having much less money we can operate with much more.

How does a leverage work?
If we want to make an order with a value of 1 lot we need 100000 base units in our account. With the leverage of 1:100 we will need to have only 1000 base units in our account. The formula for this is:

minimum base unit in your account = value of 1 lot / leverage value

Here is the example for EURUSD with the rate of 1.6234 and the leverage 1:100. The minimum base unit in your account is €100000/100 = €1000

If any order is now mode we need €1000 and if we have an account in USD, the value is converted due to current exchange rate, which for our example is 1.6234. So if we want to make the order with a value of 1 lot and the leverage 1:100 we need to have €1000 in our account * 1.6234 = $1623.40.

The leverage caused that in our order we were able to use a value of 100000 units having only 1000 units in our account. It caused also that our gains from 1 pip to 1 lot has not changed. 1 pip is still $10. As you can see leverage allows you to make large profits with a small amount of money. You must remember that it can work the other way, and may cause large losses too.