Pip Cost

kew17

Newbie
3 0
Account charges levied by a broker are a very important factor to consider especially when trend runs in the short term are of the order of 5-10 pips.

I have a GBP account using the NinjaTrader platform with FXCM who, to their credit, have separated their commission charges from spreads. Hence, spreads of the major currency pairs are now approximately 1 pip maximum. Nevertheless, there is still the pip cost of each transaction to be accounted for when calculating the profit/loss of a completed buy and sell, or sell and buy, transaction.

Roughly speaking the broker's round-trip (buying + selling) commission cost of a major pair is £6 for a 1 lot (100K units) stake. Hence, a 10 pip gross profit is 100 less £6 after having risked a stop loss of say 100 (10 pips).

But then the pip cost has to be accounted for. This is roughly 0.5 to 1 so a 1 lot stake on, say USD/JPY, reduces the gross profit to £50 (pip cost=0.5) less £6, or a 1 lot stake on, say EURGBP, keeps the gross profit at £100 (pip cost=1) less £6. Clearly, EURGBP stakes offer the most profit potential but EURGBP is not a particularly volatile currency pair and, since most of the major currency pairs have a pip cost of 0.5 to 0.65, stakes in other pairs can halve one's perceived profit. On the plus side though, actual losses are less than the perceived losses so there can be some cancelling out in an account but overall a good trader should have less losses than wins.

Does any other trader have a comparative comment to make on their broker's costs or are there better services elsewhere? The pip cost I experience seems to be a "glossed-over" cost. It is stated to be an exchange rate adjustment but to me it is effectively a charge.
 

Jason Rogers

Senior member
2,772 93
The pip cost I experience seems to be a "glossed-over" cost. It is stated to be an exchange rate adjustment but to me it is effectively a charge.

Hi Kew17,

Welcome to the forum! :)

Regardless of the currency pair you trade, FXCM converts your profits and losses into your account currency at no charge to you. The conversion is done at the market rate with no markup added.

Let's take your example of a standard lot (100k) trade on USD/JPY. That has a face value of 100,000 USD. That exact value of one pip on this trade size is 1000 JPY.

To convert this into GBP, let's assume GBP/JPY exchange rate of 186.46 (the actual conversion would be done at the live rate which changes in real time).

1000 ÷ 186.46 = 5.363080553469913 = about 5.36 GBP

While the pip cost column on our Trading Station platform shows you a rounded value, the unrounded value is used to calculate your P/L to the penny. You can confirm this by placing some large test trades on an FXCM demo account.

Also, when comparing EUR/GBP to other currency pairs, you're right to evaluate the volatility and the pip cost, but you should also consider the face value of the trade. For example, one standard lot of EUR/GBP has a face value of 100,000 Euros which is about 25% more than one standard lot of USD/JPY which has a face value of 100,000 US dollars.

I trade a strategy that involves having positions in 10 currency pairs, and I try to have the same face value for each. That means for every 100k EUR/USD position, I must trade 125k USD/JPY based on the current EUR/USD exchange rate of 1.2453.
 

kew17

Newbie
3 0
Hi Jason

Thank you for the welcome.

I have read that you are the FXCM guru on Trade2Win and so far your response has been a ray of sunshine. However, I need more sunshine to get a fuller understanding of what is happening in the forex market.

A search of Google, Investopaedia, and brokers including FXCM has not given me much understanding of the pip theory of trade valuation - but things are changing.
My understanding to date is that, for each currency pair, the P/L result of each stake will be determined by the pip value of the second (quoted) currency.
For example, for a 100K stake (in the base currency) using current market prices, my calculations with the following pairs yields -
GBP/JPY Pip Value 1000 JPY = 5.36 GBP
GBP/ USD " 10 USD = 6.37 GBP
USD/ JPY " 1000 JPY = 5.36 GBP
EUR/USD " 10 USD = 6.37 GBP
EUR/ CHF " 10 CHF = 6.60 GBP

There is a factor of 10 between these values and the pip cost column on the Trade Station platform. I suppose there is a further adjusting factor. And I suppose the uncanny equality of some pip values above has something to do with the US dollar domination of the market.

I like your idea of equal face values because one could then compare the profit productivity of your 10 currency pairs. Has this been done to get a rough idea of the best pairs to trade? I would expect EUR/ GBP to be among the poorest.
 

Jason Rogers

Senior member
2,772 93
My understanding to date is that, for each currency pair, the P/L result of each stake will be determined by the pip value of the second (quoted) currency.
For example, for a 100K stake (in the base currency) using current market prices, my calculations with the following pairs yields -
GBP/JPY Pip Value 1000 JPY = 5.36 GBP
GBP/ USD " 10 USD = 6.37 GBP
USD/ JPY " 1000 JPY = 5.36 GBP
EUR/USD " 10 USD = 6.37 GBP
EUR/ CHF " 10 CHF = 6.60 GBP

There is a factor of 10 between these values and the pip cost column on the Trade Station platform. I suppose there is a further adjusting factor.

You are correct that the value of a pip is determined by the second currency which is referred to as the quote or counter currency. Below is a demonstration of why on a 100K position the value of 1 pip is 1000 JPY for GBP/JPY and 10 USD for EUR/USD.

Suppose the current GBP/JPY exchange rate is 183.79
If I buy 100k GBP/JPY, that means I'm buying 100,000 GBP for 18,379,000 JPY.
If I later sell GBP/JPY at 183.80 then I would make a 1 pip profit.
That means, I would sell 100,000 GBP for 18,380,000 JPY.
That means my 1 pip profit was equivalent to 1000 JPY.

Suppose the current EUR/USD exchange rate is 1.2505
If I sell 100k EUR/USD, that means I'm selling 100,000 EUR for 125,050 USD.
If I later buy EUR/USD at 1.2504 then I would make a 1 pip profit.
That means, I would buy 100,000 EUR for 125,040 USD.
That means my 1 pip profit was equivalent to 10 USD.


And I suppose the uncanny equality of some pip values above has something to do with the US dollar domination of the market.

Actually, has to do with the exchange rate between the currency of your account and the counter currency of the pair you are trading. For example, if you have a GBP-denominated trading account, then to convert 1000 JPY into pounds, you would use the GBP/JPY exchange rate. If you want to convert 10 USD into pounds, then you would use the GBP/USD exchange rate.

If the exchange rates are as follows, you can see why the pip costs for different currency pairs are also similar.

GBP/USD 1.5741
GBP/JPY 183.79
GBP/CHF 1.5109
EUR/GBP 0.7948 (since GBP is the counter currency, you must multiply instead of divide the Euros you have to calculate your P/L in GBP)


I like your idea of equal face values because one could then compare the profit productivity of your 10 currency pairs. Has this been done to get a rough idea of the best pairs to trade? I would expect EUR/ GBP to be among the poorest.

It seems like you are trying to equate higher volatility with higher quality, which is not necessarily the case. The greatest volatility is usually found in exotic currencies like the Turkish Lira (TRY) and the South African Rand (ZAR) and while there is opportunity to be had in trading them, it comes with commensurate risk.

If you are new to trading forex, it might be a better approach for you to look to minimize your risk. There is already enough risk build in by the fact that you are still learning the ins and outs of this market. A good starting point for you might be the profitability studies conducted by the research team at DailyFX.com: http://bit.ly/176qmFT
 
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kew17

Newbie
3 0
Jason

Thank you for your explanation of pip value. It is very clear.

To round off, what I had tried to say earlier is that, for each pip change in the exchange value of a currency pair, more GBP profit (or loss) is made from the pip change in the EURGBP currency pair. Unfortunately, the pip range of trades in this pair are not as great as the pip range in say EURJPY. However, because the pip cost of EURJPY is roughly half that of EURGBP (0.53 at the last check) EURJPY needs to move twice the amount to make the same profit (or loss) as EURGBP. In other words, a EURGBP pip is approx. 2 EURJPY pips. So volatility needs to be considered along with pip cost when trading. Experience will soon tell me whether all that is worth knowing.
But I will say now that the pip cost is not a broker charge but a mathematical consequence.

Thanks for the link http://bit.ly/176qmFT which I will study. I have already learnt that minimising loss is much harder than gaining profit. The stop loss seems to be the only way to treat a stake that goes the wrong way, but it always seems to be brutal and expensive.
 
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AliForexTalks

Junior member
34 2
The pip value is calculated by multiplying one pip (0.0001) by the specific lot/contract size. For standard lots this entails 100,000 units of the base currency and for mini lots, this is 10,000 units. For example, looking at EUR/USD, a one pip movement in a standard contract is equal to $10 (0.0001 x 100 000).
 
 
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