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"Pip value and margin"
One of the first decisions you need to make as a trader at the start of a trade is which lot you will trade. The choice of trading volume depends on many psychological factors: emotional comfort, potential risks, choice of trading volume. All of this is closely related to risk management.
What is margin and its role in risk management;
The role of the lot in trading and risk management;
How to calculate the cost of one pip.
The size of the trading lot will directly affect the size of your profit and potential risks. The lot also determines the size of the margin (collateral) for the transaction, the value of the pip.
When you open a deal, you need a certain amount of funds in your account as collateral, this is the margin. Margin is funds that are frozen when a position is opened. While the deal is active, this amount cannot be withdrawn from the trading account, but it will again become available for withdrawal after the deal is closed.
It is important to know what the margin amount will be, so that you can not only assess the risk itself, but also calculate whether the remaining funds will allow you to open additional positions. Remember that when using leverage, you only need a fraction of the par value to open a position.
For example, with a leverage of 1: 200, you only need 0.5% of the asset's par value. Typical leverage ranges from 1 to 100, which means that you only need 1% of the face value of the asset. This will allow you to get a higher return on your investment, but it also increases the potential risk. You can also potentially suffer increased losses if the market moves against you.
Let's say you want to open a trade with 1.00 lot in EUR / USD with a leverage of 1: 100. At the same time, you do not know what the par value of the lot for this instrument is. You can find this information in the tool properties.
On EUR / USD, the par value per lot is $ 100,000. If the leverage is 1: 100, then you only need 1% for the margin of this trade, calculated in the base currency of the pair. Thus, you need 1000 $ in order to open a trade with a volume of 1.00 lots.
From a risk management perspective, margin is very important. There is a general rule that the size of the margin, that is, the collateral for transactions, should not exceed 30% of the deposit.
Returning to the above example: if your initial capital is $ 5,000, and you want to open a deal with a volume of 1.00 lots, and your leverage is 1: 100, then the margin for the deal will be $ 1,000 or 20% of your deposit.
It is important that before opening a trade you estimate the maximum margin, do not violate the risk management rules that you have established for yourself. Compliance with risk management rules is very important if you want to be successful in the financial markets.
The second factor that will be influenced by the size of the volume is the pips value. It is very important to know the value of a pip so that you can calculate the potential risk and the amount of profit that you can get before opening a trade.
To calculate the pip value, you can use the instrument characteristics table or the trader's calculator.
Pips pricing example
If you open a 1.00 lot EUR / USD trade and the market moves 100 pips in your favor, then you will make a profit of $ 100, since one pips costs $ 1: $ 1 x per 100 pips = $ 100.
On the other hand, if the market moves 50 pips in the wrong direction, you will incur a loss of $ 50: $ 1 x 50 pips = $ 50.
Calculating the pip value will help you in the following situations.
- when you want to calculate the potential profit and risk;
- if you want to set Stop Loss and Take Profit, find out their value in dollars.
The general idea is that you should not risk more than 5% of your total capital on a single trade. The reason is that you need to diversify your risks, "don't put all your eggs in one basket."
Examples of deal calculations
You have the opportunity to make a profitable purchase on the EUR / USD pair. You calculated that this pair will rise by 2,000 pips, but at the moment it may fall by no more than 500 pips. Thus, if you open a long position on this pair, calculated for growth, you can set Take Profit 2,000 pips above the trade open price, and Stop Loss - 500 pips below the open price.
If you open a 1.00 lot trade, each pips will be worth $ 1. If the deal is closed by Take Profit and your forecast comes true, you will earn $ 2,000. But if the forecast for any reason is not confirmed, then your trade will be closed by Stop Loss, and you will lose $ 500 from your deposit, which is equivalent to 10%. This is a violation of the rules of risk management.
Thus, in order to reduce your risks to 5% in this transaction, you need to halve the trading lot: from 1.00 to 0.50. In this case, the pip value will decrease from $ 1 to $ 0.50. Let's recalculate Take Profit ($ 0.50 x 2,000 pips = $ 1,000) and Stop Loss ($ 0.50 x 500 pips = $ 250). We see that the potential profit on the trade is $ 1,000 and the potential risk is $ 250.
Manage your risk right
As shown above, pip value and margin play a critical role. Selecting the optimal trading lot size is an important part of trading as it can both simplify and complicate trade management.
Moreover, pip value and margin are also important in terms of risk. If your trade is too big, then a small step can completely take you out of the game. You must understand and consider these metrics. This will help you trade responsibly and also potentially increase your chances of successful trading.