Calculation Of The Contract Value (The Purchase Cost)

 
When "USD" Comes Last In The Pair

In this first example, we're going to purchase 1 contract (100K units) of EURUSD. The current rate is 1.2345.

Remember that in "EURUSD", the ordering of first "EUR" followed by "USD" means that you are buying EUR using USD.

The real question is then, "how many US dollars is it going to cost me to buy 100K units of EUR?" And because the Euro is a little stronger than the US Dollar at this time, it's going to cost you more than US$100K.

If you buy 1 contract (100K units), and the current EURUSD price is 1.2345, the purchase price is:

1.2345 x 100K = US$123,450

So the contract value is US$123,450.

If the price of EURUSD then went up 1 pip to 1.2346, the new contract value is:

1.2346 x 100K = US$123,460

We can therefore come to the conclusion that, if you buy 1 contract (100K units) of EURUSD, you gain US$10 for every 1 pip move upwards, and you lose US$10 for every 1 pip move downwards.

And in fact, this rule holds true for any currency that ends in USD. E.g. AUDUSD, GBPUSD, NZDUSD.

For AUDUSD, the Aussie Dollar is currently weaker than the US Dollar, so you would expect it would cost less than US$100K to purchase 100K units of AUD:

0.6789 x 100K = US$67,890

To summarise, when USD is last in the pair, and you are purchasing 1 contract, simply multiply the rate by 100K to get the contract value (the purchase price in terms of USD). And remember that each pip is worth US$10 to you.
 

When "USD" Comes First In The Pair

If the currency starts with USD, such as USDJPY, then remember that you are buying USD with JPY. So now the contract value is in JPY.

123.45 x 100K = 12,345,000 Yen

What does that mean for you if your account is in USD? Well, you know the USDJPY rate - it's 123.45 in this example. So to work out how much 12,345,000 yen is in terms of USD, just divide it by the rate:

12,345,000 / 123.45 = US$100K

Which should not be surprising. Because we were purchasing 100K units of USD, and 100K units of USD tends to work out to cost US$100K :-)

What fluctuates though, is how much each pip is worth to you.

Remember that when you buy 1 contract, and USD comes last, each pip is worth US$10. When USD comes first, each pip is actually worth $10 of the other currency (1000 Yen in this case):

1000 Yen / 123.45 = US$8.10

That result hopefully makes sense. If the USDJPY rate is 123.45, it means the USD is stronger than JPY. So 1000 Yen should work out to less than US$10.

If the Yen was stronger, e.g. at 95.67, then the USD per pip (when you buy 1 contract) becomes:

1000 Yen / 95.67 = US$10.45

So how much you win or lose per pip actually changes as the rate changes, when USD comes first in the pair. But the contract value in terms of USD does not change.
 

When "USD" Is Not In The Pair At All

Let's go with AUDNZD for this example, with the rate being 1.2345.

With AUDNZD, you are buying 1 contract of AUD with NZD. The contract value is going to be in NZD:

1.2345 x 100K = NZ$123,450

So it costs more than NZ$100K to buy A$100K. Which makes sense because the Aussie Dollar is currently stronger than the New Zealand Dollar.

To get that contract value of NZ$123,450 back to USD, now you also need the NZDUSD rate. Let's say it's 0.5678. USD is second in the pair, so the contract value in terms of USD is therefore:

NZ$123,450 x 0.5678 = US$70,094.91

With USD being stronger than NZD, it makes sense to me that NZ$123,450 is about $US70K. And I have to let you in on a little secret here - while I've been writing this article that's always how I've checked if what I'm doing is correct or not - "does the result make sense?".

The end result is that to buy 1 contract of AUDNZD at 1.2345, it costs US$70K.

Why are we converting back to USD? Because most people have their currency accounts denominated in USD. If yours is not, you would hopefully take the knowledge gleaned from above, and work out how to convert the contract value from NZD into whatever currency you use.
 

Buying Less Than 1 Contract

Should you buy 10K units instead of the full contract, divide both the contract value and how much you win or lose for each pip or down, by 10.

Should you buy 1K units instead of the full contract, divide everything by 100. So yes it only costs US$678.90 to buy 1K units of AUDUSD, but also you only win US$0.10 for every pip gained.
 

Why Is The Contract Value Important

Because you can only buy as much currency as your account balance allows.

With shares it's easy - 1000 shares at $50 each means you need $50K in your account if you want to buy that many.

With currency, as demonstrated above, there's a bit more to it.

The good part is you don't really need to do the calculations if you are not so inclined. You could simply try and place the order without checking your account balance first. If you don't have enough in your account, you're broker won't let you place the trade. A bit lazy, but sometimes there's just not enough time.
 

Why Is The Amount Won/Lost Per Pip Important

Because you need to work out how much you're going to lose if your stop loss is hit.

You don't want to place your stop loss based on how much you're going to lose though. Prices move up and down all the time, and as such you need some wiggle room between the entry price and the stop loss. If you place the stop loss based on how much you are going to lose, it may well end up in striking distance of an average-sized "wiggle".

Instead, you should calculate by some other means where the stop loss should go (in broad strokes, determine the normal wiggle size and put it just outside that range).