What to Know before you Trade
There are many terms that you will come across during your learning phase. Some we have already talked about and some we will get into now.
What is an ECN?
Electronic Communication Network is the name given to trading platforms that automatically match customer's buy and sell orders at stated prices. These stated prices are gathered from different market makers, banks, and even other traders who use the ECN. Whenever a certain sell or buy order is made, it is matched up to the best bid/ask price out there.
Due to the order matching, ECN brokers typically charge a very small commission for the trades you take. The combination of tight spreads and small commission usually make transaction costs cheaper on ECN brokers.
What is a pip?
You may or may not have heard of a “pip” but this a common term used in the forex market. It refers to the smallest movement that a currency exchange rate can make. In our example we said that EUR/USD had an exchange rate of 1.3400, if this exchange rate was to increase by 1pip then the new exchange rate would be 1.3401, if the rate increased by 25pips it would be 1.3425. If the EUR/USD fell by 50pips the exchange rate would be 1.3350.
Most currency pair exchange rates are priced to the fourth decimal place, frequently making the fourth decimal place represent the pip value. However, for currency pairs like the USD/JPY, which are only priced to the second decimal place, the pip value is not the fourth decimal place but instead the second. So a two pip increase could be represented by a change of 85.35 to 85.37.
What is a pipette?
Some brokers, like AAAECN quote currency pairs beyond the standard 4 and 2 decimal places to 5 and 3 decimal places. This is because they are quoting fractional pips, also called pipettes. For example, if the EURUSD moves from 1.34011 to 1.34012, it moved one pipette.
What is a lot?
A lot is the smallest trade size available and is determined by the account type. A standard size for a lot is 100,000 units.
In most cases when you purchase 1 standard lot each pip (incremental move in the exchange rate) will result in a $10, loss or gain, depending on whether you bought or sold the currency pair.
However it is not all the time that 1 standard lots pip movement will be $10.
How to calculate a pip value?
Let's assume we will be using a 100,000 unit (standard) lot size. We will now recalculate some examples to see how it affects the pip value.
- USD/JPY at an exchange rate of 76.70 (.01 / 76.70) x 100,000 = $12.89 per pip
- USD/CHF at an exchange rate of 0.9229 (.0001 / 0.9229) x 100,000 = $10.83 per pip
In cases where the U.S. dollar is not quoted first, the formula is slightly different.
- EUR/USD at an exchange rate of 1.3400 (.0001 / 1.3400) X 100,000 = 7.46 x 1.3400 = $10 per pip
- GBP/USD at an exchange rate or 1.5400 (.0001 / 1.5400) x 100,000 = 6.49 x 1.5400 = 9.9946 rounded up will be $10 per pip