What are pip value and margin in Forex?

What are Pip value and margin?

One of the first decisions you will need to make as a trader when starting out is choosing a trading volume to apply to your positions. But how much money should you use for each position?

The choice of trading volume will depend on many psychological factors such as emotional comfort and risk aversion, but the choice of trading volume will also be closely related to the risk management to be applied. In other words, understanding trading volume is crucial, as the volume you choose will determine both the margin and the pip value.

What is Margin?

When opening a trade, a certain amount of your funds is needed. This is known as margin. Margin is not a cost, but an amount of money that is frozen when a position is opened and is returned once the transaction has been closed. It is important to know how much of the margin will be used so that you can assess not only the risk itself but also calculate the remaining funds that will allow you to open additional positions.

Remember that with CFDs, you only need a fraction of the face value to be able to open a position. For example, with a leverage of 1: 200 only 0.5% of the face value would be needed for the margin of the transaction. Typical leverage is 1 to 100, which means that only 1% of the face value of the margin would be needed. That allows you to generate a higher return on invested capital, but at the same time, it also increases the risk.

Let’s say you want to open a 1 lot GBP / USD trade with 1: 100 leverage, but you don’t know what the par value per lot of that instrument is. This information can be found in the instrument specification table.

On GBP / USD, the par value per lot is £ 100,000. If the leverage is 1: 100, only 1% is needed for the margin of this trade, calculated in the base currency of the pair. Therefore £ 1000 is required for the margin of a 1 lot transaction.

From a risk management point of view, the margin is very important and the general notion applies that traders should not enter trades with a margin greater than 30% of total invested capital.

Going back to the previous example, if your starting capital is £ 5,000 and you would like to open a 1 lot trade, your required margin with 1: 100 leverage would be £ 1000. It is important that before opening a trade, you evaluate which one. It will be your maximum margin, and it won’t break any rules you set for yourself. By following strict risk management regulations, you will be successful in the financial markets.

What is Margin and Leverage?

What is Pip value?

The second factor that will influence is the pip value. In the investment process it is very important to know the value of the pip, especially for risk management purposes. You must know how your portfolio will be affected if the market goes 100 pips in your favor, or 100 pips against.

In order to calculate the pip value, you can use the instrument specification table.

In order to calculate the value of the pip times 1 lot, the “nominal value of a lot” is multiplied by the “size of a PIP” and the value will be in the quoted currency:

100,000 x 0.0001 = $ 10

This means that if you open a 1 lot trade on GBP / USD and the market moves 100 pips in your favor, you would have a profit of $ 1,000 (USD 10 x 100 pips). On the other hand, if the market does not move in your favor, you could generate a loss of $ 1,000. This calculation will help you assess at which market level you could hit your maximum loss, and where you can possibly assign a stop loss.

The general idea is that no more than 5% of your total capital should be risked on one position. The reason for this is that trading is based on probability and you should give your strategy a chance for evaluation, to identify if you have a higher probability of achieving success.

Let’s look at an example. Let’s say you open a 1 lot GBP / USD traded with a pip value of £ 10. You have a rule of not risking more than 5% of your total capital. Therefore, your total capital is £ 5,000 so your maximum accepted loss will be £ 250, which is approximately $ 380.

If you know that 1 pip is worth $ 10 and the maximum accepted loss is $ 380, then dividing $ 380 by 10, the maximum stop loss level will be 38 pips.

What are Pip and Fractional Pip in the Forex?

Manage risk appropriately with XTB

As can be seen, both the pip value and the margin play an important role in trading. Choosing an optimal position size is a vital part of investing as it can make it easier or more difficult to manage the position after opening a trade. What’s more, the pip value and margin are also important from a risk point of view.