You will see the following terms quite a lot when trading in forex: currency pair, and trade sizes, in pips and lots. But what exactly do they mean?
Well, a pip is usually referred to the smallest amount by which the value of a currency pair can change. For example, when the value of the GBP/USD pair goes up by a pip, the quote will move from 1.22221, to 1.22222, and therefore the size of the movement is just one pip, and so on.
For those who are new to trading, success or loss in a trading account can be measured by pips instead of the actual dollar value. A one pip gain in a US$1 account, is equal, in terms of the trader’s skill, to a 1 pip gain in a US$100 account.
A ‘lot’ is the smallest size in currency trading for forex traders. The lot is size is 100,000 for US Dollar based pairs. Basically, this means that when you instigate a trade with your Margin account, the smallest amount that you can buy or sell is 100K. This is regardless of the size of your Margin in the first place.
Margin and Leverage
The ‘Margin and Leverage’ are two very important concepts in forex trading, which carries a very high degree of risk. Margin is the total amount of money required as a “good faith deposit” in order to create a place for your trade. It depends on the account type you hold, trading instrument’s liquidity and volatility, and it is updated periodically for price oscillations.
For example, when you open a forex account with LeoPrime, we will request that you deposit a small sum, known as Margin, as insurance against the losses that your account may suffer. With this small sum, you’re able to control a much larger amount, enabling greater gains, but also greater losses than you would be able to achieve with your deposit.
The financial instrument which allows you to take a position that is worth more on the market than your initial outlay is a Leveraged product. Different Leveraged products work in different ways, but all amplify the potential profit and loss for a trader. Leveraged products will almost always require you to pay Margin.
It’s easier to understand Margin and Leverage in the context of a borrowing process. The lots that you can trade are borrowed from LeoPrime, and we require a Margin deposit as an insurance against losses. The ratio between the funds borrowed by you, and the Margin that you deposit as insurance is called Leverage.
Therefore, if you set a Leverage ratio of 100:1, enabling the trade of US$1,000,000 with just a $US10,000 in deposit, but eventually trade just 100,000, then the actual Leverage that you would be using is 10:1. You can see more about our Leverage and Margin offering by clicking this link.
It is vitally important that you must gain a good understanding of Leverage in order to understand how to manage your account. A general rule of thumb says that increasing Leverage = increases risk.