About Quote, Decimal, Pip Value and Position Sizing
I saw a question from a reader named George, “How to calculate (determine the number of lots, pen. ) for USD / JPY which is five decimal places? My balance is $ 1000 with a 5% risk? 100 pips stop loss. “
Hm … to be honest I have never seen a forex broker who quotes USD / JPY with five decimal places. As far as I know, the quote for USD / JPY generally uses two to three decimal places. In fact, for currency pairs the counter currency is JPY, as far as I know it is a maximum of three decimals.
The emergence of questions like the one I quoted above makes me think, it seems there are still fellow traders who misunderstand the meaning of “decimal”. So, instead of errors like that continuing, this time I want to explain a little about the quote of two decimals, three decimals, four decimals and five decimals.
Quote, decimal and pip value
In the language of mathematics, “five decimal numbers” means “five numbers behind a comma”. Now, in the price quote we usually see, the “comma” is replaced by “point”.
120.12 is an example of a quote with TWO DESIMAL .
120.123 is an example quote with THREE DESIMAL .
1.1234 is an example of a quote with FOUR DESIMAL.
1.12345 is an example quote with FIVE DESIMAL.
But, actually how many decimals are the same way.
George said that the stop loss limit that he set was as far as 100 pips. The problem is, 100 pips in USD / JPY can not know how much USD exactly, before we know at the price level how many stop losses are placed. As we know, the 100 pips (for quotes with THREE decimals) are worth 10,000 JPY (ten thousand yen). Where do we get this value from?
The story begins with the following formula:
Pip Value = Minimum Price Fluctuation x Contract Size
The formula above is the formula for determining the value per pip in forex trading .
Contract size for forex (regular) is 100,000 (one hundred thousand) base currencies . In the USD / JPY quote that uses three decimals , the Minimum Price Fluctuation is 0.001 . If we put the numbers into the formula above, the results are:
Pip Value = 0.001 (JPY / USD) x 100,000 USD = 100 JPY
So, 1 pip for USD / JPY with a 3 decimal quote is worth 100 JPY. Thus, 100 pips is worth 10,000 JPY (ten thousand yen).
Please don’t be confused because I actually use “comma” to separate thousands, not dots. It is commonly used in international writing. In addition, the “point” in forex trading is actually used to separate DESIMAL , not thousands.
So, when we speak in ” forex trading language”, start getting used to this writing procedure. Of course the habit doesn’t need to be carried around when we talk about things outside of trading. Must be able to adjust the time and place.
Calculation for two decimals
Well, if for example it turns out that the USD / JPY quote is TWO DESIMAL , then the Minimum Price Fluctuation is 0.01 . Thus, assuming that the Contract Size is 100,000 (one hundred thousand) base currencies, the calculation of the value per pip (pip value) is as follows:
Pip Value = 0.01 (JPY / USD) x 100,000 USD = 1,000 JPY
George has set a 5% risk limit of $ 1,000 meaning the amount of the stop loss is only $ 50 once “shoot”.
If the stop loss is 100 pips, that means 100,000 JPY (one hundred thousand yen). The question is then, how many 100,000 JPY is USD? This question CANNOT BE ANSWERED before we know IN LEVEL HOWEVER the stop loss is placed. Once we know at what level the stop loss is placed, then we just put the number into the formula that I have shown in the article above.
For example: George buy at 120.00. Then George technically sees that the stop loss level is at 119.00 (as far as 100 pips). That means, when prices touch 119.00; George’s stop loss is worth approximately 840.34 USD.
That number is obtained from a formula that you can find in my article that discusses position sizing . The formula is as below:
Total Stop Loss / Stop Loss Price Level = 100,000 / 119.00 = 840.34
Due to George’s risk limitation of only 50 USD per transaction (5% of $ 1,000), by applying the formula in the article about the position sizing above, George may only enter a position of 0.05 lots.
The calculation is like this:
Maximum Lot Total = Risk/transaction / Total Stop Loss = $50/$840.34 = 0.059 Lot
Unfortunately, on FOREXimf.com or other Indonesian legal brokers, the minimum lot is 0.1 lot. Thus, based on the trading plan as stated by George, he could not enter the position. The solution is to increase the risk limit or reduce the stop loss distance.
If only the quote that you see for USD / JPY is FIVE DECIMAL, you actually just enter the numbers as in this example.