Beginning on the Forex

A pip :

The pip is the weaker possible variation on a currency. On the eur/usd, the weaker variation is of 0.0001. In fact, if the eur/usd goes from 1.2850 to 1.2851, there is a 1 pip bullish variation. If the gbp/usd goes from 1.9000 to 1.8999, there a 1 pip bearish variation. If the usd/chf goes from 1.2235 to 1.2335, there is a 100 pip variation.

The pip is a bit different on the usd/jpy, it as of 0.01 pip.

When you trade on the Forex, you have a purchase price (ask) different from the buying price (bid). The difference between the purchase price and the buying price is called spread. In general, it is the broker’s or price maker’s single pay. In fact, on the Forex, there are no expenses for storage of commissions.

 

The spread

It is the difference between the purchasing price and the selling price on an exchange rate. If the exchange rate of the eur/usd is of 1.2850-1.2853, the purchasing price is of 1.2853 and the buying price is of 1.2850. So when you make a transaction on the Forex, it is directly losing 3 pips (more or less depending on the broker).

If you by eur/usd at 1.2853 (you’re directly losing because the selling price is of 1.2850) and if the exchange rate increase at 1.2863-1.2866 ; you win 10 pips because you bought at 1.2853 and cut your position with the selling price at 1.2863.

 

Selling at 1.2863 (Bid 1.2863 - Ask 1.2866)

Purchase at 1.2853 (Bid 1.2850 - Ask 1.2853)

 

It is possible to make a transaction in the reverse direction beginning by selling and cutting your position with a purchase.

If you sell eur/usd at 1.2850 (you’re directly losing because the purchase price is equal to 1.2853) and if the exchange rate decreases at 1.2837-1.2840, you win 10 pips because you sold at 1.2850 and cut your position with the purchasing price at 1.2840.

 

 

As the volatility is weak on the Forex, the brokers allow the use of leverage.

 

Leverage:

The leverage allows the trader to realize more important trades than if he only uses his initial margin deposit. The broker put to his client disposal a more important margin than the trader’s margin deposit.

If the trader opened an account with a € 10 000 deposit (10k) and if the broker put to the trader disposal a leverage of 50, so the trader has a € 500 000 margin (500k). This leverage enables the trader to make transactions for a higher amount. In fact, the volatility on the exchange market is quite weak; the brokers put to the traders’ disposal the leverage.

Without the leverage, the maximum trade would be equal to € 10 000 (10k), so a purchasing position of € 10 000 (10k) on the eur/usd at 1.2800 (Ask 1.2800 – Bid 1.2797), a 103-pip variation that would lead the exchange rate to 1.2900 (Ask 1.2903 - Bid 12900) would make the trader win $100 (10k/trade = 1$/pip).

Thanks to a leverage of 50, if the trader makes a maximum purchasing transaction on the eur/usd of € 500 000 (500k) at 1.2800 (Ask 1.2800 - Bid 1.2797), a 103-pip variation that would lead the exchange rate to 1.2900 (Ask 1.2903 - Bid 1.2900) would make the trader win $ 5 000 (500k/trade = 50$/pip).

 

The trader is not forced to use the maximum leverage proposed by his broker!!! The trader has to cope with his risk as the leverage enables to increase his gains in the case of winning trades but also to increase his loss on case of losing trades. So the trader has to choose the size of his positions according to the risks he wants to take with his portfolio.

 

Margin deposit ---- Margin with a leverage of 50 ---- Maximum Trade ---- Gain/pip

€ 2 500 ----------       € 125 000  -----------------            125 k -------------------- 12.5$ / pip

€ 5 000 ----------       € 250 000  -----------------             250 k -------------------- 25 $ / pip

€ 10 000 ---------       € 500 000  ----------------             500 k -------------------- 50 $ / pip

€ 50 000 ---------       € 2 500 000  --------------             2.5 m -------------------- 250 $ / pip

€ 100 000 --------      € 5 000 000  --------------             5 m ----------------------- 500 $ / pip