Pip and Lot in Forex: Essential Concepts to Master for Effective Trading

If you are just entering the world of forex trading, the words “pip” and “lot” will be your long-term companions. But what exactly are they? Why are they important? This article will help you understand these basic concepts.

Lot: The unit of trading volume

When participating in forex, you cannot simply enter any amount into the system. Instead, you must follow standard trading sizes called lot.

What is a lot? Simply put, a lot is a measurement unit of currency volume in each trade. A standard lot typically equals 100,000 units of the base currency.

However, to help retail investors easily enter the market, today’s trading platforms offer various sizes:

• Standard lot: 100,000 units
• Mini lot: 10,000 units
• Micro lot: 1,000 units
• Nano lot: 100 units

Choosing a lot size depends on your capital and risk tolerance.

How to calculate the amount needed to buy a lot

The question is: How much USD do you need to buy 1 lot? The calculation formula is quite simple:

Amount needed = Lot value × Leverage ratio

Real example: You want to buy 1 standard lot USD/CAD with a leverage ratio of 1:50. The amount you need is: 100,000 × (1/50) = 2,000 USD

If the currency pair does not have USD as the base currency (such as EUR/JPY), you need an additional conversion step:

1. Calculate the amount in the base currency: 100,000 × (1/50) = 2,000 EUR
2. Convert to USD at the current exchange rate: 2,000 × 1.1086 = 2,172.2 USD

Fortunately, trading software will do the calculations for you. However, understanding how to calculate helps you manage your capital more wisely.

Pip: The smallest price movement unit

If a lot is “volume,” then pip is “the value of the smallest price movement.”

What is a pip? Abbreviation for Percentage Interest Point, pip represents the smallest price change in a currency pair. When you see EUR/USD rate from 1.1050 to 1.1051, that’s an increase of 1 pip.

The pip rules are not very complicated:

• For pairs without JPY: pip is at the 4th decimal place (0.0001)
• For pairs with JPY: pip is at the 2nd decimal place (0.01)

Why is JPY different? Because the Japanese Yen is not divided into smaller units like other currencies, so the rate has only 3-4 decimal places instead of 5.

Below pip is point (or pipette). The relationship between them: 1 pip = 10 points.

Quick reference table

How to calculate pip value – Converting pip to real money

This is the part most new traders find difficult. But you only need to follow 3 simple steps:

Step 1: Determine the value of 1 pip in the base currency

For example, with EUR/JPY at rate 118.721:

• Pip value = 0.01 ÷ 118.721 = 0.0000842311 EUR

Note: Use 0.01 for pairs with JPY, use 0.0001 for other pairs.

Step 2: Convert to USD (if needed)

If the base currency is not USD, multiply by the current exchange rate:

• 0.0000842311 EUR × 1.1050 = 0.0000930754 USD

Step 3: Multiply by lot size (100,000)

• Pip value for EUR/JPY = 0.0000930754 USD × 100,000 = 9.31 USD

This means: each time EUR/JPY changes by 1 pip, your account changes by 9.31 USD (if trading 1 standard lot).

From pip to actual profit

Suppose you trade 1 lot EUR/JPY and the price increases by 10 pips:

• Profit = 9.31 × 10 = 93.1 USD

If you trade 10 lots and the price increases by 5 pips:

• Profit = 9.31 × 5 × 10 = 465.5 USD

But be careful: losses are calculated similarly. A 5 pip decrease on 10 lots could mean losing 465.5 USD.

Why understanding pip and lot is important?

Most brokers provide automatic calculation tools. But knowing how to do it manually has practical benefits:

1. Better capital management: You will understand exactly how much you are risking
2. Estimate expected profit: Before entering a trade, you know your target and potential loss
3. Smart lot selection: Mini lot or standard lot? Decide based on calculations, not emotions
4. Avoid basic mistakes: Many new traders lose money because they don’t understand these concepts well

Points to remember

• What is a pip? The smallest price movement unit, usually at the 4th decimal place (or 2nd with JPY)
• What is a lot? The standard volume of each trade
• JPY is an exception: For Yen, pip is calculated at the 2nd decimal place, not the 4th
• 1 pip = 10 points: Point is a smaller unit than pip
• Lot size directly affects pip value: Trading 1 standard lot yields 100 times the profit of micro lot

Common mistakes

Confusing pip and point: Some new traders often confuse these two concepts. Remember: point is 10 times smaller than pip.

Not considering leverage: Leverage increases both profits and losses. A change of 1 pip can be very large with high leverage.

Choosing too large a lot: Many new traders rush into trading a standard lot when they should start with micro lots.

Ignoring exchange rates: Pip value varies with exchange rates. You need to update calculations when rates fluctuate significantly.

Conclusion

Lot and pip are not complicated concepts – they are tools to help you manage trades. Understanding how they work is the first step to becoming a smart and disciplined trader.

Before starting real trading, spend time practicing with a demo account, doing hypothetical calculations, and familiarizing yourself with these numbers. When you feel confident, you are ready.