What is a Pip?
In the world of forex trading, one term that you will hear frequently is “pip.” If you are new to forex trading, you may be wondering what a pip is and how it is used. In this article, we will define what a pip is and provide examples to help you understand its importance in forex trading.
What is a Pip?
A pip is a unit of measurement used to express the change in value between two currencies in a forex trade. The term “pip” stands for “percentage in point” or “price interest point.” It represents the smallest price movement that a currency pair can make.
Most forex currency pairs are quoted to four decimal places. For example, the EUR/USD currency pair might be quoted as 1.2350. In this case, the fourth decimal place (the zero) represents one pip. If the price of the EUR/USD currency pair moves from 1.2350 to 1.2360, that represents a movement of ten pips.
It is worth noting that some currency pairs are quoted to five decimal places, in which case the fifth decimal place represents a fractional pip, also known as a “pipette.” However, most traders simply refer to these fractional pips as pips.
Why are Pips Important in Forex Trading?
Pips are important in forex trading because they determine the profits or losses of a trade. The value of a pip will vary depending on the currency pair being traded and the size of the trade.
Let’s look at an example. Suppose you decide to buy 10,000 units of the EUR/USD currency pair at a price of 1.2350, and you later sell those units at a price of 1.2360. This would represent a profit of ten pips, which may not seem like much. However, the actual profit will depend on the size of the trade.
In forex trading, trades are typically measured in lots. A standard lot represents 100,000 units of the base currency, while a mini lot represents 10,000 units and a micro lot represents 1,000 units. So, if you were trading one standard lot of the EUR/USD currency pair, your profit would be $100 (assuming a pip value of $10). However, if you were trading one mini lot, your profit would be $10 (assuming a pip value of $1).
Different Types of Pips
There are two types of pips: pipettes and fractional pips.
- Pipettes: Pipettes are also known as fractional pips. They represent a movement of 0.1 pip. For example, if the EUR/USD currency pair moves from 1.2350 to 1.2351, that represents a movement of one pipette.
- Fractional Pips: Fractional pips represent a movement of 0.001 pip. They are sometimes referred to as “pip fractions” or “pip decimals.” Fractional pips are used when currency pairs are quoted to five decimal places. For example, if the USD/JPY currency pair is quoted as 105.235, and it moves to 105.236, that represents a movement of one fractional pip.
How to Calculate the Value of a Pip
The value of a pip depends on the currency pair being traded, the size of the trade, and the exchange rate of the currency pair at the time of the trade.
To calculate the value of a pip, you can use the following formula:
Pip value = (1 pip / exchange rate) x trade size
Let’s use an example to illustrate this formula. Suppose you are trading one mini lot of the EUR/USD currency pair, and the current exchange rate is 1.2350. You can calculate the pip value as follows:
Pip value = (1 pip / 1.2350) x 10,000
Pip value = 8.10 USD
This means that for every pip the EUR/USD currency pair moves, your profit or loss will be 8.10 USD if you are trading one mini lot.
It is important to note that pip values can vary depending on the currency pair being traded. For example, the pip value for the USD/JPY currency pair may be different than the pip value for the EUR/USD currency pair, even if the trade size and exchange rate are the same.
Examples of Pips in Forex Trading
Let’s look at some examples to help you understand how pips work in forex trading.
Example 1: Suppose you are trading the USD/JPY currency pair, and you buy one standard lot at a price of 108.50. You hold the position for a few days, and the price of the currency pair rises to 109.50. This represents a movement of 100 pips, and your profit would be 1,000 USD (assuming a pip value of 10 USD).
Example 2: Suppose you are trading the GBP/USD currency pair, and you sell one mini lot at a price of 1.3800. You close the position a few hours later at a price of 1.3750. This represents a movement of 50 pips, and your profit would be 50 USD (assuming a pip value of 1 USD).
Example 3: Suppose you are trading the EUR/USD currency pair, and you buy one micro lot at a price of 1.2000. The next day, the price of the currency pair falls to 1.1950. This represents a movement of 50 pips, and your loss would be 5 USD (assuming a pip value of 0.1 USD).
Conclusion
In conclusion, a pip is a unit of measurement used to express the change in value between two currencies in a forex trade. Pips are important in forex trading because they determine the profits or losses of a trade. The value of a pip will vary depending on the currency pair being traded, the size of the trade, and the exchange rate of the currency pair at the time of the trade. By understanding pips and how to calculate their value, you can better manage your trades and make more informed trading decisions.