Beginner Level

Learn basic topics about forex, platforms and trading.
If you are new to the markets, start here.

Lesson 8: Pip Value & Margin

Margin

You will need a certain amount of money to
open a trade. This is known as margin. The margin is not a price, but
an amount of money that is frozen once you open an account and is returned to
you once the transaction has been closed. It is important to know what the size
of the margin will be, so that you can determine not only the risk itself, but
also calculate whether the remaining funds will allow you to open additional
positions.

Note, with CFDs, you only need a fraction
of the nominal value to be able to open the spot. For example, with a 30:1
leverage, you would only need 3.33 per cent of the nominal value for the
transaction margin. Typical leverage for FX is 1 to 30, which means that you
would only need 3.33 per cent of the nominal value of the margin. It helps you
to potentially generate a higher return on the capital invested, but also
increases the risk, which means that you may need to deposit additional funds
to cover your position. If the place moves against you, you will also incur
greater losses.

Let’s assume that you would like to open a
1 lot trade on GBP / USD with a leverage of 30:1, but you don’t know what the
nominal value per lot is for this instrument. This information can be found in
the specification table of the instrument.

In GBP / USD, the nominal value of the lot
is £ 100,000. If the leverage is 30:1, you will only need 3.33% for the
margin of this exchange, which is measured in the base currency of the pair.
Therefore, you need £ 3,333.33 for a 1 lot payment margin.

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

Returning to the example above, if your
initial capital is £ 5,000 and you would like to make a 1 lot deal, that would
reflect 66.67% of your total capital, because the appropriate 30:1 leverage
margin would be £ 3,333.33.

Pip
Value

The second variable that determines the
size of the volume is the pip value. It is very important to know the pip value
in the investment phase, particularly for risk management purposes. You will
know how the portfolio will be impacted if the market goes 100 pips to your
favor, or 100 pips to you.

You can use the instrument description
table again to measure the pip value.

In order to calculate the pip price of 1
lot, you multiply the “Nominal Price of one lot” by the “Price
of one PIP” and the value will be in the quoted currency:

100000
x 0.0001= 10 USD

It means that if you open a 1 lot exchange
for GBP / USD and the market shifts 100 pips to your benefit, you will make a
profit of $1,000 (10 USD x 100 pips). On the other hand, if the market does not
shift to your favor, you would have a loss of $1,000. This estimate will help
you determine at which market rate your total agreed loss may be, and where you
may be able to assign a Stop Loss order.

The general idea is that you should not be
in a position to lose more than 5% of your total capital. The explanation for
this is that trading is based on probability, and you should give your plan a
chance to evaluate whether you are more likely to achieve victory than loss.

You open a 1 lot payment for GBP / USD with
a pipe price of £ 10. You will also follow the rule that you do not allow a
loss of more than 5% of your total capital. As a result, your total capital is
£ 5,000, and your maximum agreed loss is £ 250, which is roughly $380.

When you know that 1 pip is worth $10 and
your maximum agreed loss is up to $380, then by multiplying $380 by 10, your
maximum Stop Loss rate is 38 pips.

Manage
the risk properly

As shown above, both pip price and margin
play an important role in trading. Choosing the correct size of your trading
position is a vital part of trading, as it can make it easier or more difficult
to handle your position after a trade has been opened. In addition, the pip
value and the margin are also significant from a risk point of view. If your
trade is too high, a small move could take you out of it. That’s why both of
them need to be understood to help you trade wisely and potentially increase
your chances of good trading.