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In most cases, a pip is equal to .01% of the quote currency, thus, 10,000 pips = 1 unit of currency. In USD, 100 pips = 1 penny, and 10,000 pips = $1. A well known exception is for the Japanese yen (JPY) in which a pip is worth 1% of the yen, because the yen has little value compared to other currencies. Since there are about 120 yen to 1 USD, a pip in USD is close in value to a pip in JPY. (See Currency Quotes; Pips; Bid/Ask Quotes; Cross Currency Quotes for an introduction.)
Because the quote currency of a currency pair is the quoted price (hence, the name), the value of the pip is in the quote currency. So, for instance, for EUR/USD, the pip is equal to 0.0001 USD, but for USD/EUR, the pip is equal to 0.0001 Euro. If the conversion rate for Euros to dollars is 1.35, then a Euro pip = 0.000135 dollars.
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Most forex brokers allow a very high leverage ratio, or, to put it differently, have very low margin requirements. This is why profits and losses can be so great in forex trading even though the actual prices of the currencies themselves do not change all that much—certainly not like stocks. Stocks can double or triple in price, or fall to zero; currency never does. Because currency prices do not vary substantially, much lower margin requirements is less risky than it would be for stocks.
Most brokers allow a 100:1 leverage, or 1% margin. This means that you can buy or sell $100,000 worth of currency while maintaining $1,000 in your account. Mini-accounts can have leverage ratios as high as 200.
The margin in a forex account is a performance bond, the amount of equity needed to ensure that you can cover your losses. Thus, you do not buy currency with borrowed money, and no interest is charged on the 99% of the currency’s value that is not covered by margin. The margin requirement can be met not only with money, but also with profitable open positions. The equity in your account is the total amount of cash and the amount of unrealized profits in your open positions minus the losses in your open positions. Your total equity determines how much margin you have left, and if you have open positions, total equity will vary continuously as market prices change. Thus, it is never wise to use 100% of your margin for trades—otherwise, you may be subject to a margin call.
So if you buy $100,000 worth of currency, you are not depositing $1,000 and borrowing $99,000 for the purchase. The $1,000 is to cover your losses. If the equity in your account drops below the margin requirement, then you will have to deposit more money, or the broker will liquidate your positions. Thus, buying or selling short currency is like buying or selling short futures rather than stocks.
Leverage is inversely proportional to margin:
Leverage = 1/Margin = 100/Margin Percentage
Margin Percentage = 100/Leverage
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