If you are a beginner trader interested in synthetic indices, one of the first things you need to learn is how to calculate pips in synthetic indices. Mastering pip calculation can help you measure price movements, estimate potential profits and losses, and manage trading risk better.
What Are Synthetic Indices?
Synthetic indices are a special group of trading instruments generated using algorithms and number generators. Each index is designed to reproduce specific market movements.
Depending on the provider, different synthetic indices may represent different levels or patterns of volatility. As such, understanding the index’s contract specifications is important when calculating pips.
What Is a Pip?
In layman’s terms, a pip is a standardized unit used to describe a change in the price of a financial instrument. Synthetic indices can use different price formats and decimal conventions. Therefore, do not assume that one pip always equals a particular decimal place.
As mentioned, correct synthetic index pip calculation depends on the index’s specification. When learning how to calculate pips on synthetic indices, consider the following: current price of the index, number of decimal places quoted, lot size, and minimum price movement.
How to Calculate Synthetic Indices Pips
Before calculating pips, identify the smallest or standardized price increment used by your trading platform. Let’s use an example of a synthetic index quoted at: 1,234.56. If its minimum price movement is 0.01, then one minimum price movement equals $0.01.
However, if it is quoted at 1,234.567 and its minimum movement is 0.001, the calculation changes. Therefore, when learning how to calculate pips in synthetic indices, you should first ask, “What is the minimum price movement for this particular synthetic index?”
This information is normally available in the instrument’s specifications on your trading platform or through the broker offering the synthetic indices.
Step-by-Step Process: How to Calculate Pips in Synthetic Indices
- Identify the Entry and Exit Price
The first step is identifying your entry price. For example, if you opened a trade at 850.00, your entry price is 850.00. Next, determine where you intend to close the trade or position. Let’s say in this instance it is 855.00.
- Calculate the Price Difference
Now, let’s find the price difference. Keeping up with our example, we subtract the entry price from the exit price: 855.00 − 850.00 = 5.00.
- Determine the Pip Size
With this in hand, the next step is to determine the pip size. If the index’s specification indicates that 1 pip = $0.01, then 5.00 ÷ 0.01 = 500 pips. Our trade therefore represents a 500-pip movement under that pip convention.
- Determine the Monetary Value
The number of pips alone does not tell you how much money you made or lost. For this, you also need to know the monetary value of each pip for your particular trade size. The basic formula is: Profit/Loss = Number of Pips × Pip Value.
So, in our case, our trade will lead to a profit of $50 because 500 × $0.10 = $50.
