In the last lesson we saw what pips are both in the definition and in the practical analysis of their returns. In This lesson instead we will see how important is the calculation of the value of pips to take into account the value of individual pips for each cross-currency. In fact, as we have just mentioned at the end of the tenth lesson, the value of PIP changes in pairs, for example in EUR/USD is 10 while in EUR/GBP is 17. The value of pips is important because on it are calculated the amount of the spread adopted by the broker, you calculate the profits and losses of the trader (US), you can calculate or plan the quota for stop limit/loss.
1 Pips and the Spread of the Broker
2 Pips in the calculation of profits/losses
3 Pips to plan stop limit and stop loss
Pips and the Spread of the Broker
In practice, when you enter an order you ask the broker to make a service on which the broker gets his earnings. In fact, the broker does not earn depending on whether we win or lose, he is completely indifferent, but earns only when we make a purchase order or sale, or when we open a position on the rise or fall. On the real stock exchange, on the other hand, there are transaction costs. The profit of the broker is calculated from the difference between bid and ask, called spread. For example, if the cross EUR/USD is quoted at 1,300/1,302 the spread will be 2 pips. In practice, for each position open on that cross the broker will gain a PIP value multiplied by 2. For example, if for a lot of EUR/USD the PIP is 10 (as we have seen) the profit of the broker will be 20 (2 pips x 10). These 20 will be deducted in an immediate way from the available capital.
Pips in the calculation of profit/loss
In Lesson 10, we made an example of how to calculate profits based on PIP changes in the value of cross-currency, but we failed to specify what is happening with the spread. For example, if we have a capital of 5,000, a margin of 600, a change in our favour of 4 pips we should also consider the value of the spread so the account of the available capital will be given by 5,000 – 600 + 40 (4 Pips) – 20 (spread) = 4,600. If we close the operation at that time we will have the 600 to guarantee therefore 5,200 of available capital.
Pips to plan stop limit and stop loss
Knowing how much is worth an upward or downward pip is very important to understand how much you can earn or lose from an operation. For example, if we want to open a purchase position on a cross because we are convinced that this will get an increase of a pip we will know that equivalent to 10 in the case of EUR/USD or only 8 for the USD/JPY. If in the first case the gain is 100, in the second case with the same sum the gain is 80. A particular not of little account. So if we want to set stop limit and stop loss we will have to remember this difference, because if we want to reach a target of gain expressed in euros (eg I want to earn 1,000 euros), we will have to calculate the amount of the desired figure according to Pips of Cross on which you invest.
We invite you to lesson 12 where we will go even more on the practical aspect related to pips.