Pips measure currency price movements, typically 0.0001, varying for JPY pairs.
Spreads are a broker's embedded fee, reflecting the bid-ask price difference.
Over 68% of Australians prioritise low commissions and tight spreads when choosing a platform.
What are pips?
Pips are units of measurement that are used to track the price change between two different currencies in forex trading.
Pip is short for "percentage in points" and 1 pip is equal to one-hundredth of 1%, or 1/10,000th.
In decimal terms, this means 1 pip is 0.0001.
As most brokers quote currency pairs out to 4 decimal places, a pip is the smallest possible price movement between currency pairs.
However, some brokers will offer fractional pips (known as pipettes), which are equal to 0.00001 (5 decimal places).
If that isn't complicated enough, the bid and ask prices for Japanese yen (JPN) currency pairs are only quoted to 2 decimal places. As a result, a pip is equal to 0.01 for JPY pairs (or 0.001 for pipettes).
What's an example of a pip?
Say a broker might announce that they offer minimum spreads on the AUD/USD currency pair from 1 pips (some brokers will also use points instead of pips when outlining the spread).
If we have a sell price of 0.76594 and a buy price of 0.76604, we'd have a spread of 0.0001, which is 1 pip.
What is the spread in forex?
No matter what currency pair you're trading, your broker will list two prices – the bid price and the ask price.
The bid price shows the value at which you can sell the base currency of the pair, while the ask price is the price at which you can buy it from the broker.
(Remember, the base currency is the one listed first.)
The difference between these two prices is known as the spread, and the ask (buy) price is always higher than the bid (sell) price.
Taking our AUD/USD currency pair again, where the broker has a sell price of 0.76594 and a buy price of 0.76604.
Subtract the sell price from the buy price and you get the spread: 0.0001 (or 1 pip).
What does the spread mean for me?
Have you ever seen "no-commission" forex trading advertised and wondered how the broker makes any money? While a broker may not charge any commission on trades, that doesn't mean they offer their services for free.
Instead, rather than charging you a separate flat fee, the spread essentially allows the broker to incorporate their commission as part of your transaction.
This is how brokers make a profit – they sell currency at a higher price than the price they buy at.
Of course, there are also other factors that can affect the size of the spread, including the volatility and liquidity of the currency pair you're trading.
That's why major currency pairs have tighter spreads than emerging market pairs.
Calculating the price of a pip
Now it's time to think about how the price movement in a currency pair affects your potential profit or loss. To do that, you need to calculate the value of a pip, which depends on the pair you're trading, the exchange rate and the size of your trade.
If you're trading a major currency pair where 1 pip = 0.0001, the formula is simple:
Pip value = (trade amount x 0.0001) / the current spot price of the forex pair.
Let's say you place a $10,000 long trade on AUD/USD at 0.7651.
The value of AUD/USD then increases to 0.7681 – an increase of 0.0030, or 30 pips.
The value of a pip is (100,000 x 0.0001) / 0.7681.
So 1 pip is $13.02, and the profit on the trade would be 30 x $13.02, or $390.60.
What is a lot?
When you trade forex, you'll be working with lots.
Forex is commonly traded in specific amounts. These amounts are measured in lots, which is the number of currency units you're trading.
Basically, a lot is a unit of measuring a transaction and is how orders will be quoted by your broker.
A standard lot is the equivalent of 100,000 units of the base currency.
But there are also mini, micro and nano lots that are 10,000, 1,000 and 100 units respectively.
But remember, lots trade based on standard sizes.
100,000 units = 1.00 lot
10,000 units = 0.10 lot
1,000 units = 0.01 lot
Let's put this into perspective.
Say you have 100,000 units of AUD/USD.
And let's say the Australian dollar against the US is currently trading for $1.20.
If you were to receive 100,000 units of Australian dollars, in return you would have to pay $120,000 US dollars.
Finder survey: What features matter most to Australians when choosing a forex trading platform?
Response
Low commissions
68.18%
Tight spreads
30.3%
Easy to use platform
27.27%
Good range of forex pairs
27.27%
Quality trading tools
24.24%
Security and regulation
22.73%
Speed of execution
18.18%
High liquidity
15.15%
Available platform (e.g. MT4)
9.09%
Technical analysis tools
7.58%
Availability of less common pairs (e.g. exotics)
4.55%
Personal advice services
4.55%
None of the above
3.03%
Source: Finder survey by Pure Profile of 1145 Australians, December 2023
What other costs do I need to be aware of in forex trading?
While many brokers make money from the spread rather than a commission, some also charge a separate flat commission on all trades.
This means they may offer tighter spreads than you can find elsewhere, but you'll need to consider the total cost of trading before deciding if this approach will be more cost-effective for you.
If you're a casual trader, you might be best suited to a zero-commission account, depending on the broker. In this case, you'll want to look for the lowest spreads on no-brokerage-fee accounts.
Other trading charges may also apply. For example, you may be charged interest if you want to keep a position open overnight, the broker may charge a fee when you want to withdraw funds from your account or a currency conversion fee could apply if you trade in a currency other than your account's base currency.
With this in mind, be sure to read the terms and conditions of your trading account closely.
Our expert says: Beware of inactivity fees
"One other common fee to keep an eye out for is an inactivity fee. This fee is often charged on a monthly basis if you don't make any trades over a certain period, which is generally 12 months."
Disclaimer: General information only. All forms of investments (and in particular, trading CFDs, commodities and forex) carry significant risk, including the risk of losing more than the invested amounts, market volatility and liquidity risks. Past performance is no guarantee of future results. Such activities are not suitable for most investors.
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Tim Falk is a writer for Finder, writing across a diverse range of topics. Over the course of his 20-year writing career, Tim has reported on everything from travel and personal finance to pets and TV soap operas. When he’s not staring at his computer, you can usually find him exploring the great outdoors.
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