Definition of a pip
Pip stands for Price Interest Point. A pip measures the amount of change in the exchange rate for a currency pair. In the forex market a pip is the 4th decimal place in a currency pair. For example if the price of EURUSD was 1.2000 and it moves up to 1.2001 we will say EURUSD has risen by 1 pip. i.e. 1.2001 – 1.2000 = 0.0001 which is 1 pip. This applies to all currency pairs except yen pairs (JPY) In the JPY pairs it is the second decimal place. If we were to take an example of the current USDJPY rate being 120.00 and it moves to 120.01 it will have risen by 1 pip.
Determining Pip Value
If you go to buy sugar from the market you will find it being sold in Kilograms or in Grams. You cannot tell the shopkeeper to give you 2 liters of sugar can you? There is a measurement unit for everything you buy and sell. This applies to the forex market as well. The measurement unit for currencies is called lots. We have micro, mini and standard lots. 1 micro = $1000 and 1 mini lot = $10,000 and 1 standard lot =$100,000
Now to determine pip value we can take our previous example of EURUSD price being 1.2000 and moving to 1.2001 which is a 1 pip gain. So if you had traded 1 Micro lot it will be $1000 x 0.0001 = $0.1 and if you had traded 1 mini lot it would have been $10,000 x 0.0001 = $1 and if you had traded 1 standard lot $100,000 x 0.0001 = $10. It can vary slightly from broker to broker and currency pair. Instead of doing such long calculations I just use the following rule of thumb :
1 micro lot = $ 0.1
1 mini lot = $1
1 std lot = $10
So if you traded 2 micro lots it would be $0.2 and so on.
In the forex market it is easy to make money for only one reason; leverage. Without leverage you would only be able to trade the lot size with the amount of money you put in to your account. If you have a leverage of 1:1 and have $1000 in your account you will only be able to trade 1 micro lot. Now suppose in the whole month you make 250pips, that would mean $25 profit on a $1000 account. As you can see that is not a very huge amount and you could probably make more money working on a minimum wage job.
So if you use a leverage of 50:1 it means the broker is giving you $50 to trade with for every $1 in your account. Again if you have a $1000 account and leverage of 50:1 it means you can trade
50 x $1000= $50,000 so you can trade up to 5 mini lots. So if you were to still to make the 250 pips trading 5 mini lots you would gain 250 x $5 = $1250. Now $1250 is a good amount to make in a month. The problem with using high leverage comes in when you loose. You stand to gain a great deal but also to loose a great deal at the same time. Supposing you were trading 5 mini lots on the $1000 account you would only need to loose 200 pips to wash out your account. You can read more about Forex Leverage.
One has to be really careful when using leverage. Proper money management techniques have to be used.