​What does it mean when they say '50 pips?' A ‘Pip’ is a term used to determine how much a currency pair has moved in price and stands for “price interest point.” They measure the smallest amount of change in the exchange rate. For currency pairs which have four decimal places, one pip is equal to 0.0001 (the fourth decimal place).

A movement in a rate from 1.2684 to 1.2685 is a 1 pip movement. Some currency pairs which are quite high numerically only use two decimal places (most notably the Japanese Yen) and 0.01 is 1 pip. Several platforms offer fractional pips which just mean a fifth decimal place (or three in the case of the Yen). These fractional pips are called pipettes and are used for increased accuracy.

 

Contract & lot sizes

​

​

In forex terms, one ‘lot’ is a similar way to saying one contract or number of units. Understanding what size contracts to trade allows traders to manage the position sizing used for appropriate leveraging and therefore risk management.

On a standard contract (1 lot trade size) is equal to 100,000 units of the currency traded (If we are trading dollars the amount is worth $100,000). Two contracts would be worth $200,000 and so on. Trading platforms to accommodate smaller trades have created mini, micro and nano lots. This allows traders to expose much less and enter into smaller positions. Each position is decreased by a multiple of 10.

Standard lot:       100,000 units

Mini lot:                10,000 units

Micro lot:              1,000 units

Nano lot:               100 units

 

Example: A trader has 1 standard contract open and is controlling a $100,000 trade open on the AUD/USD. The trader opened a trade to buy AUD against the USD at 0.9330 and closed the trade at 0.9350, making 20 pips profit (0.9350 – 0.9330 = 0.0020).

In order to calculate how much this trade made we multiply $100,000 * 0.0020 = $200 (same as 20 pips x $10 per pip). This is a $10 move for every pip. If the trader entered into 1 mini contract/lot, the profit would be $20 instead of $200 as the controlling lot size would be $10,000.

 

Note: Contract value and therefore pip movement value when trading on platforms is determined by what the 'quote/term' currency is (i.e. USD ($) in the above AUD/'USD' example).

This will be important when learning about risk management and stop losses. Knowing how much money is at risk depending on how much the currency moves is crucial. Traders can therefore determine how much capital they can afford to risk and where to place stop losses.

 

Currency Cross Pairs

 

 

Currency crosses enable the exchange of currencies without needing to first exchange it into USD, as was done initially. Once upon a time, if someone wanted to use their Canadian dollar to buy the British pound, they would first need to change the Canadian currency at the USD/CAD rate, and then use the USD amount to change into GBP. These days, accessing the direct currency cross pair of GBP/CAD is simple!

Trading cross currency pairs

Given the US dollar's remaining presence in global markets, there is a lot more influence on USD pairs (the majors - more popular liquid currency pairs). Trading currency crosses may provides a range of opportunities not entirely influenced by the global reserve currency. Examples why cross pairs can be a great choice are:

​

• They may be less likely to be influenced by large spikes linked to the US. Gradual trends may be more probable to continue on its path without large shocks to the trend.

• US dollar pairs have been known to be influenced more by the big global banks.

• Eliminates synthetic pairs by opening two trades to get the same result of a cross currency pair. Example, seeking EUR/JPY by buying EUR/USD and buying USD/JPY (the USD cancels each other out and you have the same result as a EUR/JPY trade). This is seen with institutional trading when not enough liquidity is available on the cross pair, so they use the USD pair instead. Doing this yourself will only cost you the spread twice as well as tie up more capital in margin. 

• Currency crosses can provide hints about the strength of major pairs. Assessing the EUR/AUD may indicate which of EUR/USD or AUD/USD is better. If EUR/AUD trended upwards (strengthening EUR), then buying the EUR/USD may be smarter than buying AUD/USD.

• News regarding a non-US economy may be more likely to impact that currency greater when paired against another non-US currency.

Cross currencies however are not as popular and will have less people trading them. This means liquidity may be lower and unusual changes in volatility may be seen. 

Calculating currency cross pairs

Manually calculating a cross rate is simple (although unnecessary platforms provide the cross rate already). Special arbitrage traders do however use mismatched rates from different sources to make risk free profits. Large institutions have scanning software and significantly large sums to buy and sell tiny mismatches in the rates to capture risk free profit.

For example, in order to determine the GBP/CAD we need to use rates with a common denominator (most typically USD). By using rates from USD/CAD and GBP/USD, we can multiply them together to get the cross pair. 

Given USD/CAD = 1.3000

Given GBP/USD = 1.5000

Then GBP/CAD = 1.9500 (1.3000 x 1.5000)

For this to work, the currencies being multiplied need to have the common currency (USD) on opposite sides. If you are trying to work out the cross pair for currencies with the USD on the same side, all you need to do is invert one of them to switch the sides. Inverting the rate is simply dividing 1 by the rate (1 / rate). For example if you are trying to find out what the AUD/EUR rate is by using the AUD/USD and EUR/USD, you cannot just multiply them as is.

Given AUD/USD = 0.7500

Given EUR/USD = 1.3000

Then AUD/EUR = ((0.7500 x (1 / 1.3000)) = 0.5769… simple

 

Interest rate rollovers

 

 

Remembering that trading on margin is effectively trading on borrowed money, at the end of each day if a trade is still open it will experience an interest rollover (overnight rolls). 

Interest is calculated on the position size and either added to or subtracted from your account, depending on which currency pairs are traded and in which direction. As we know from previous topics, trading currency is buying one currency while selling another and therefore borrowing one currency to buy another. Interest is therefore paid to the broker on the currency borrowed and earned on the currency bought.

Each currency has a prevailing interest rates set by central banks. Buying a currency with a higher domestic interest rate than the one selling will result in interest earned. When the base currency has a lower interest rate than the quote/term, the forward rate curve will also be positive for that pair. Tip: Buying a pair with a positive forward curve will cost interest while shorting the pair will earn interest.

 

Trading interest rate differentials & carry trade

It seems now we can make money, while making money. Buying a currency with a higher interest against a currency with a lower interest rate, while also being on a winning trade direction, we have essentially earned a little bonus on our trade (given the trade is left open overnight). The concept of trading on interest rate differences is known as carry trade.

 

Remember trading on leverage can lose much more in getting the direction wrong over interest earned keeping the trade open. Buying a currency with 6% p.a. interest against a currency with 2% p.a. has a 4% p.a. difference. Trading at 200 times leverage, 4% p.a. is similar to 800% p.a. (4% x 200 times leverage) if we compare the interest against the amount needed in margin. It is just as important to be mindful of longer term positions which may end up paying relatively high interest rate differentials.

Keeping a position open runs the risk of staying in a market moving against the trader which could cause high losses. Using stop-losses can help manage this risk. Planning to trade a position for longer periods of time (long-term trend trading), calculating whether the position will pay interest or cost interest is worth knowing. 

 

1. Understand interest rate differentials with high returns

2. Strong and stable trends can result in earning the interest rate differential as well as a profit on the trade