What are Pips in Forex

The word pip can also be written as ‘percentage in point’ in forex trading. In the foreign exchange market, a pip refers to the minimum or smallest price change that a given exchange currency can experience. It also serves as a way to measure currency trading. People who trade, use pips to keep track of how much currency prices go up or down. Calculating the number of pips in a price move is easy but depends on the forex pair being traded.

What are ‘Pips’ in Forex Trading?

In the Forex market, the last decimal digit is considered the lowest price that is worth changing, however, this is not the case in an actual scenario. For the majority of the major currency pairs such as the US dollar, Euro, and the Great Britain pound, the currency quotes are usually rounded to 4 decimal places, and thereby, during this scenario, 1 pip is equal to 0.0001.

Therefore, if for instance, the GBP/USD pair moves from 1.4000 to 1.4001, this move is generally regarded as a much 1 pip movement.

Pips and Pipettes

For a more compressed spread, the currencies can be priced in increments known as pipettes, where the decimal spot is 5, or at 3 if using JPY. One pipette can be represented by the pip’s tenth place.

EUR/USD example:

EUR/USD = 1.60731
Pip = 1.60731 to the EUR USD exchange rate less 0.000 30
Pipette = EUR/USD = 1.60731 – 0.00001

The fourth decimal place is called the pip, while the fifth is referred to as the pipette.

What is a Pip Value in Forex Trading?

The pip value denotes the monetary worth assigned to a movement of one pip in a specific foreign exchange transaction and is frequently utilized in discussions regarding the losses or profits of a position.

The meaning of pip value differs between currencies, although most major currency pairs tend to be priced to four decimal places, so a pip often equates to the fourth figure after the decimal point.

As pips have small values, forex trading occurs in micro lots, mini lots, and standard lots, which are 1,000, 10,000, or 100,000 units of currency respectively. Even though the value of a pip isn’t that much, with the use of leverage it can amount to substantial exposure and can significantly alter your open position.

The pip’s value relies fully on the traded currency pair, the transaction’s volume, along with the recent exchange rate of the currency pair. To calculate the value of a pip, simply divide the pip amount by the current market price of the forex currency pair. Then, multiply this number by your lot size, which is how many base units you’re trading.

Normally you will not have to calculate the value of the pip yourself since your forex broker or provider will do it for you, but it is helpful to know it by knowing it.

How to Use Pips in Forex Trading?

A trader decides to take a long position on the GBP/USD currency pair at 1.5000. The price rises to 1.5040. Here, the price has increased by 40 pips in their favor, which offers the possibility of closing the trade at a profit. The price in theory moved 40 pips against the trader and could potentially lead to a negative result in this trade if it is closed.

Besides facilitating the measurement of price changes and the resulting gains and losses, pips are significant in forex trading in risk management and determining the level of leverage to employ.

In specific, one of the scenarios that a trader can face includes having to place a stop-lossorder, which, in this instance, shows the highest number of pips the trader is okay with losing on the trade.

It is important to note however that placing a stop-loss is very effective in minimizing losses where the currency pair moves against the trader’s expectations.

Pip Value Calculator

The determination of the pip’s value is done based on the amount of profit or loss each pip of movement makes. To understand how to calculate pip value, we should consider these three aspects: the currency pair to be traded, the amount of trade, and the existing spot price. A currency pair, along with the exchange rate and trade volume, determines the worth of a pip.

The Pip Value Formula:

The general formula for the computation of a single pip value in the case of a four-priced decimal currency pair is:

The Pip value is calculated as 0.0001 multiplied by the trade amount and then divided by the spot price.

How to Calculate Pips?

For instance, let’s say a trader places a long trade worth $100,000 on the USD/CAD currency pair, and the current exchange rate is 1.0548.

Later, the exchange rate increases to 1.0568. In this case, where one pip is equal to 0.0001, the trader has also recorded a profit of 20 pips since 1.0568 – 1.0548 = 0.0020, which translates to a value of 20 pips.

Value of Pip in USD = (0.0001 x 100,000) / 1.0568 = $9.46

To determine the amount of a trade that is marked as profit or loss, we take the number of pips that the trader has gained and multiply by the value of a pip.

At this point, the trader had made a profit of 20 x $9.46 = $189.20.

What Causes Pip Values to Change?

The pip value of most currency pairs will depend on the base value of the trader’s account. For instance, in the case of a USD account, which is usually the case for most of the currency pairs, takes all currency pairs having USD in the quote currency; it is, therefore, evident that the value of a pip will always read $10 for any standard lot, $1 for a mini lot, and $0.10 for a micro lot.

The Pip values would only change if the USD was either the first or the base currency in the pair, or if it wasn’t involved in the pair at all, and when the value of the USD fluctuated by more than 10% in either direction.

Conclusion

Ultimately, understanding pips is very important for forex traders because it enables them to assess how much money they stand to gain or lose, thus allowing them to control their leverage and risk.

By Joseph