The Forex fundamentals

How to trade Forex without huge investments

Welcome to the second lesson of our Forex Basic course.

In this lesson you will learn:

  • what currency pairs and quotes are

  • what pips and points are

  • what a lot is and how to calculate the profit on your order

  • how to operate huge amounts without investing them

Currency pairs

In the Forex market, currencies are quoted in pairs. In these pairs, the first currency is named ‘base currency’ and the second one is named ‘quote currency’. The price of a pair indicates the amount of the quote currency required to buy or sell one unit of the base currency. For instance, if the price of EUR/USD is 1.18165, then to buy 1 EUR you need to spend 1.18165 USD.

Pip and point

Prices constantly change in the Forex market. However, they usually tend to only vary by a very small percentage. These tiny changes are represented by changing of the last two digits in quotes. The fourth digit after the point is called a pip, and the fifth digit after the point is called a point. To see, how it appears in a live example, take a look at the quote EUR/USD amounting 1.18165: ‘5’ stands for points and ‘6’ for pips. Let’s presume that the price for this example has changed from 1.18165 to 1.18175 it means that it has increased by 1 pip or 10 points.

Quotes generally have five-digit pricing, except some currency pairs. The most widely-spread are the pairs with Japanese yen. They have three-digit pricing, for example, USD/JPY. In this case, the last digit in the quote also stands for a point and the second last stands for a pip. Therefore we have an example: a change in USD/JPY quote from 109.455 to 109.462 means that the price has increased by 0.7 pips or 7 points.

What is a lot, mini lot, and micro lot?

The main market players are constantly exchanging hundreds of millions of currencies. To make calculations faster and easier, they measure these amounts in lots. One standard lot equals 100,000 units of base currency. For a long time, the lot size was a minimum order volume, which is indeed an overwhelming amount. This barrier to entry made Forex an exclusive playground for central banks and financial institutions. Most individual traders couldn’t trade such vast amounts of currency.

Later on, brokers opened the doors of the Forex market to all comers. The OctaFX broker makes Forex accessible by offering two important options. It is introduced reduced order volumes called mini lots and micro lots. While one lot equals 100,000 units of a base currency, a mini lot equals 10,000 units of a base currency, and a micro lot equals 1,000 units of base currency. For example, if EUR/USD quote amounts 1.18165, this means one lot costs 118,165 USD; accordingly, one mini lot costs 11816.5 USD and one micro lot costs 1181.65 USD.

What is leverage?

Leverage is an individual loan extended to a trader at the time when he or she opens an order. Let’s say you are applying leverage of 1:500. This means you can trade one lot of EUR/USD by only investing $236.38 of your own money. Accordingly, to trade one mini lot, you need $23.64. And to trade one micro lot of EUR/USD, you can invest as low as $2.36 of your funds. 

In summary, the leverage of 1:500 allows you to open orders that are 500 times bigger than your investment. So you only lay an insignificantly low amount of your money at stake. That is how OctaFX allows you to build an effective strategy without taking excessive risks.

How to calculate your potential profit

To calculate an outcome of your order, you need to know the cost of one pip. This will also help you to forecast possible risks. A pip’s value is expressed in the currency of your trading account: this may be either USD or EUR. If you open a USD trading account, it makes it easier for you to measure pip prices for pairs that include USD as a quote currency. For example, if we take the EUR/USD pair, the monetary expression of one pip for a standard lot on your account is calculated as follows:

100,000 units of base currency × $0.0001 = $10

Hence, the pip’s price for a mini lot is $1, and the pip’s price for a micro lot is $0.1.

In such a manner, you can calculate that if you buy one lot of EUR/USD, and the price increases by ten pips, you earn $100. If you trade a currency pair where USD is not the quote currency, the pip price will firstly be counted in the quote currency and then converted into USD according to the Forex exchange rate.

To determine the potential profit of your order before placing one, you can conveniently use the profit calculator on the OctaFX website. View it, choose a currency pair, and fill in the details of your order—that’s all you need to do to get approximate numbers. Here is how it works: if you buy one lot of USDJPY, and price increases by ten pips, your profit amounts $89.95.

Now let’s summarise what we’ve learned from this lesson:

  • Currencies are quoted in pairs. You can buy or sell the base currency for the quote currency.

  • Each pair has five-digit pricing except USD/JPY, which has three-digit pricing. The last digit called a point and the second to last, a pip.

  • The standard volume for trading on Forex is called a lot and equals to 100,000 units of base currency. OctaFX allows you to divide a lot into mini lots and micro lots.

  • OctaFX provides you with leverage to trade Forex without vast amounts of personal investment. It allows you to open orders 500 times bigger than your initial investment.

 

In the next lesson, you’ll learn how to use leverage to earn more than 100% of the value of your investments.