Most experienced forex traders calculated their success in terms of pips with regards to considering generated profits in their daily trades. But what are pips and how can they generate profits? In forex, traders must be aware of the terms that define the amount to which one can generate profit or loss. This basic knowledge is vital for any trader, in order for him or her to further implement money management tactics effectively.
Profit Limit / Take Profit
Profit limit or take profit point is another type of pending order that you set at the exact point at which you are convinced that the profit earned, from that particular trade, will meet your requirements. Buying AUD / USD at 1.0320 and setting the profit limit at 1.0370, means that when the price moves up and reaches 1.0370, the long position on the Aussie (AUD / USD), would automatically close, giving you the profit of 50 points / pips . Setting profit limits helps you achieve the minimum amount of profit that you want on each trade, no matter where you are or what you are doing.
In the Foreign Exchange market, prices of pairs are noted in several decimal places and pip is the smallest unit of a pairs' price movement in its exchange rate. Pip stands for 'percentage in point' which is the last unit in the four decimal places price of a major currency pair and the smallest change a rate can make.
For example, if the current price of GBP / USD is 1.5685, the last decimal figure of '5' is known as pip or point. Let's suppose you bought GBP / USD at 1.5685 and sold it at the price of 1.5697, it means that you earn 12 pips or points on that trade. The profit earned from these pips depends on the lot size and the number of lots you used in that trade.
A simple formula to calculate your profit in monetary value is:
Value per Pip = [Lot size] X [Number of Lots] X [Number of Pips]
Lots and Lot Size
Whenever you enter a trade either as long or short, you are trading a certain amount of that currency's units, against its pair, in that particular trade. The amount or number of units of the currency bought or sold is called a lot. The foreign exchange market has several types of lots that are categorized according to their size; for instance the standard lot constituents of 100,000 units of the currency, mini lot is of 10,000 units, while the micro lot has 1,000 units. Let's say for example, you are trading EUR / USD and you have a long position open at a standard lot. This means you have bought 100,000 Euros against the US dollar. Or you have sold 100,000 US dollars against the Euro.
In conclusion, when a trader enters a 'long' position and the pip value increases the trader has generated a profit equal to the relevant increase in pips. Conversely, when a trader enters a 'short' position and the pip value goes up he might suffer the relevant losses in relation to the difference in pips. The best way for a newbie to fully comprehend these terms, is to open a demo account and by trading with virtual money, understand in practice how the system actually works.