For forex beginners, it is vital to learn all key terminology within the field. Before jumping immediately into trading, determining what a pip is will help with your experience and allow you to become a better trader.
Summary:
- A pip is the change in value between two currencies (most often the last decimal place of the price point).
- A pipette is one tenth of a pip.
- There are several factors when calculating a pip however most brokers will do this automatically.
- Pips are vital as they offer a standardised form of measurement in the forex market.
- The difference between the asking and bidding price (spread) is presented in pips.
What is a Pip?
A pip is a unit of measurement that measures the change in value between two currencies. It is often the last decimal point within a price quote. For example, if the EUR/USD pair moves from 1.0810 to 1.0811, that 0.0001 rise in value is one pip.
A pip is most often the last decimal place within the price point.
So, while most go to four decimal places, there are exceptions such as the Japanese yen pairs. These are quoted to two decimal places and so for these pairs, one pip is equal to 0.01. An example of this would be if USD/JPY moves from 100.00 to 100.01, then it has risen by one pip.
Through these examples, it comes as no surprise that the term pip stands for “percentage in point” or “price interest point” as a pip is equal to 1/100 or 1% of the exchange rate. Smaller price alterations can be measured in pipettes.
So, what’s a Pipette?
A pipette is one tenth of a pip. While the pip often refers to the fourth decimal place, a pipette refers to the fifth decimal place (or to the third decimal place regarding the Japanese yen pairs).
For example, if the EUR/USD moves from 1.54320 to 1.54321, it has been moved by one pipette (0.00001).
What is the difference between a Pip and Pipette? Well, the reason a trader may consider using this extra precision is that it allows an even finer control over trade entry and exit points which can be significant for high-frequency traders or those using automated trading systems.
How to calculate a Pip:
A pip value is influenced by several factors:
- The currency pair: the specific currencies you are trading e.g USD/ GDP.
- The exchange rate: the current rate.
- The trade value: the size of the trade, often measured in lots.
The simplest calculation goes as follows:
For currency pairs quoted to four decimal places:
Formula: Pip Value = (0.0001 / Exchange Rate) * Trade Size
For currency pairs quoted to two decimal places (like JPY pairs):
Formula: Pip Value = (0.01 / Exchange Rate) * Trade Size
Practical Example:
Let’s consider an example to illustrate the significance of pips in Forex trading:
Assume a trader buys 1 standard lot (100,000 units) of EUR/USD at 1.1050.
The trader sells the position at 1.1070.
The difference is 20 pips (1.1070 – 1.1050).
To calculate the profit:
Pip value for EUR/USD (assuming the USD is the account currency): 0.0001 / 1.1050 * 100,000 = 9.05 USD per pip.
Total profit: 20 pips * 9.05 USD per pip = 181 USD.
In this equation we used the assumption that the USD was the account currency however forex is a global market. Not everyone has their account in the same currency which means the pip value must be converted into whatever currency the account may be traded in.
How to find the pip value in your trading account’s currency:
In Forex trading, your account might not be denominated in the same currency as the currency pair you are trading. Hence, it’s essential to convert the pip value into your account’s currency. The conversion depends on whether the account currency is the base or counter currency in the exchange rate quote.
Steps to Convert Pip Value:
- Identify the “found pip value” in the currency pair being traded.
- Determine the conversion exchange rate between the pip value currency and your account currency.
- Perform the conversion based on whether the account currency is the base or counter currency in the conversion rate.
Conversion Examples:
Example 1: Converting GBP to USD
Found Pip Value: 0.813 GBP
Exchange Rate (GBP/USD): 1.5590
If the currency you are converting to (USD) is the counter currency:
Pip Value in USD = 0.813 GBP / 1.5590 = 0.5215 USD
If the currency you are converting to (USD) is the base currency:
Pip Value in USD = 0.813 GBP * 1.5590 = 1.2674 USD
Example 2: Converting USD to NZD
Found Pip Value: 0.98 USD
Exchange Rate (USD/NZD): 0.7900
If the currency you are converting to (NZD) is the counter currency:
Pip Value in NZD = 0.98 USD / 0.7900 = 1.2405 NZD
If the currency you are converting to (NZD) is the base currency:
Pip Value in NZD = 0.98 USD * 0.7900 = 0.7742 NZD
Will I need to calculate this?
No. Forex brokers all tend to work this out automatically but it’s always important to know the basis of what is being done behind the scenes.
If your broker doesn’t do this automatically, there are Pip Value Calculators that you can use so that you can avoid doing necessary maths!
Why are Pips significant?
Pips are vital in forex trading for several reasons.
- They offer a standardised measurement: this allows a structured way at measuring the movements of price across different currency points.
- Risk management: knowing the value of each pip allows effective stop-loss and take-profit orders, ensuring that you trade with minimal risk to your account.
- Calculation of spread: the difference between the bid and ask price is often expressed in pips.
- Profit and loss calculation.
- A way of comparing the market: linking back to standardisation of measurements, pip values allow traders to compare volatile movements across different currency pairs.
Why is the Forex spread in Pips?
The spread in Forex trading is the difference in price when buying (biding price) and selling (asking price) of a currency pair at that current moment. This spread is measured in pips.
Example:
If EUR/USD has a selling price (ask) of 1.1055 and a buying price (bid) of 1.1053, the spread is 0.0002 or 2 pips.
Calculating the Cost of Spread:
To figure out the cost of the Forex spread, multiply the spread by the size of your trade.
Example:
Currency Pair: EUR/USD
Spread: 2 pips (0.0002)
Trade Size: 50,000 units
Cost of Spread: 0.0002 x 50,000 = $10.00
This means that there is a $10.00 difference between the asking and bidding price.
Conclusion:
Understanding what pips are is fundamental to Forex trading. Pips provide a standardised way to measure price movements, manage risk, and calculate profits and losses. Now that you know what a pip is and how it is calculated, you can now begin to explore the best ways at predicting which way the pips will increase and by how many.
For more information, check out our introduction to forex beginner’s trading course. Or if you need a more personalised approach to help get you started, feel free to book a free mentoring call with one of our staff. We’ll help you start you trading journey with us in the right way.
