Why These Concepts Matter
Before you place a single trade in the forex market, you need to understand three foundational concepts: pips, lots, and leverage. These aren't just jargon — they directly determine how much money you make or lose on every trade. Getting them wrong is one of the most common reasons new traders blow their accounts.
What Is a Pip?
A pip (Percentage In Point) is the smallest standardised price movement in a currency pair. For most currency pairs, one pip equals a move of 0.0001 (the fourth decimal place).
Example: If EUR/USD moves from 1.0850 to 1.0855, that's a movement of 5 pips.
For pairs involving the Japanese Yen (JPY), one pip equals 0.01 (the second decimal place). So USD/JPY moving from 149.50 to 149.55 is also 5 pips.
What About Pipettes?
Many MT4 brokers quote prices to a fifth decimal place. This fractional pip is called a pipette (or point). So EUR/USD at 1.08504 vs 1.08514 is a difference of 1 pip and 0 pipettes vs 1 pip — just a more precise measurement.
What Is a Lot?
A lot is the standardised unit of measurement for trade size in forex. It defines how many currency units you're buying or selling.
| Lot Type | Units of Base Currency | Pip Value (EUR/USD approx.) |
|---|---|---|
| Standard Lot | 100,000 | ~$10 per pip |
| Mini Lot | 10,000 | ~$1 per pip |
| Micro Lot | 1,000 | ~$0.10 per pip |
| Nano Lot | 100 | ~$0.01 per pip |
Note: Pip values vary slightly depending on the currency pair and current exchange rate.
What Is Leverage?
Leverage allows you to control a large position with a relatively small amount of capital. It's expressed as a ratio, such as 1:100, which means for every $1 in your account, you can control $100 in the market.
Example: With $1,000 in your account and 1:100 leverage, you can open a position worth $100,000 (one standard lot).
Leverage Is a Double-Edged Sword
Leverage amplifies both profits and losses equally. A 1% move in your favour on a leveraged trade could double your investment — but the same move against you could wipe it out entirely.
- High leverage (e.g., 1:500): Small account can trade large sizes, but margin calls happen fast.
- Low leverage (e.g., 1:10): More conservative, provides a larger buffer against adverse moves.
What Is Margin?
Margin is the deposit your broker requires to open and maintain a leveraged position. It's not a fee — it's collateral held temporarily while your trade is open.
Margin formula: Margin Required = Trade Size ÷ Leverage
Example: Opening 1 standard lot (100,000) on EUR/USD with 1:100 leverage requires $1,000 margin.
Putting It All Together: A Simple Example
You have a $2,000 account, use 1:50 leverage, and buy 0.5 mini lots (5,000 units) of EUR/USD.
- Pip value ≈ $0.50 per pip.
- You set a stop-loss 20 pips away — maximum loss = $10.
- Your target is 40 pips — potential profit = $20.
- This represents a risk of 0.5% of your account — well within sensible risk limits.
Key Takeaways
- A pip is the standard unit of price movement in forex.
- Lot size determines how much each pip is worth in dollar terms.
- Leverage lets you control large positions with small capital but increases risk proportionally.
- Always calculate your pip value and potential loss before entering any trade.