How to Calculate Pips and Spreads

Determining your profits and losses is an essential part of trading so let's take a closer look at how pips and spreads factor in this equation. A pip is the smallest price change that an asset can make. In the forex market, currency pairs are often quoted in four decimal points so a 0.0001 change equates to one pip. For yen pairs which are stated in two decimal points, one pip is equivalent to 0.01.

What is a Pip

EXAMPLE 1

EUR/USD climbing from 1.3500 to 1.3400 reflects a 100-pip rally while a drop in GBP/USD from 1.3450 to 1.3400 indicates a 50-pip slide. USD/JPY rising from 94.50 to 95.75 translates to a 125-pip climb while a drop in AUD/JPY from 78.50 to 76.00 means a 250-pip selloff.

Meanwhile, the spread is the difference in the bid and ask price. The bid price refers to the rate at which the broker or market maker is buying from the trader and the ask price is the rate at which it is selling to the trader. The bid price is generally set higher than the actual market rate while the ask price is set lower than the actual market rate.

EXAMPLE 2

For instance, if the spot rate of EUR/USD is 1.3450, a broker can quote the bid at 1.3455 and the ask at 1.3445, amounting to a bid-ask spread of 10 pips. A bid/ask quote for EUR/AUD at 1.4500/1.4520 translates to a spread of 20 pips. Wider spreads can erode trading profits or magnify losses which is why narrow ones are often preferable.

When calculating your potential profit and loss, probably to see if your reward-to-risk ratio shows that it's worth taking a particular setup, don't forget to apply the right prices since the spread also impacts your bottom line profitability especially for day traders that take multiple positions in a day. These spreads also apply to stocks, commodities, indices, and futures.

Spreads explained

It's also worth noting that these spreads could also widen for some brokers, depending on market conditions. In that case, slippage can occur and cause your trade to be executed at a slightly different price than what was indicated in your stop or limit orders. These scenarios are often seen during releases of top-tier reports, session overlaps, or central bank announcements. Other brokers, however, are able to offer fixed spreads.

With that, it's important to compare spreads being offered by brokers before deciding to open a trading account with one. It also helps to practice with a demo account for your broker of choice to see how these spreads are factored in your trades. While some can offer narrow spreads during normal market conditions, widening spreads in volatile situations can also be detrimental to profitability so traders could prefer fixed spreads instead.

easyMarkets offers highly competitive fixed spreads across their tradeable instruments, namely forex, commodities, and indices. This ensures broker transparency without having to worry about additional costs from slippage. This way, you will also be able to calculate your potential risk and reward from the get-go since the price you click is the price you get. There are inherent risks to any investments you make and especially with trading. Make sure you understand the costs of your trading as well as the risks.


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