In Forex trading, a pip (which stands for Price Interest Point) is a unit of measure that expresses the change in value between any two currencies. In Forex trading, the value of any given currency pair is given in pips. One pip is equivalent to 0.0001, two pips is equivalent to 0.0002 etc. This may however vary as we will see below. It’s also important to note that pips express the change in value both upwards and downwards.
Pips and currency pairs
To be able to understand what a pip is in-depth, it’s important to understand what currency pairs are. Forex trading can be defined as the simultaneous buying of a currency and selling another. In simpler terms, Forex trading is about buying and selling currency pairs which are simply ratios of currencies in respect to each other. When you buy one currency in a currency pair, you automatically sell the other currency in the currency pair. The opposite is also true i.e. when you sell one currency, you automatically buy the other one. There are many currency pairs the major ones being; EUR/USD, GBP/USD and USD/JPY. Each currency pair assumes a value which represents the strength of one currency against another at any given time.
If the currency pair such as EUR/USD moves from 1.4000 to 1.4001, that represents a 0.0001 USD increase or simply a one pip increase. The same applies if the currency pair makes a similar move but in the opposite direction. A move from 1.4000 to 1.3999 is still a one pip increase if a trader had sold the currency pair.
Pips are usually calculated based on four decimal places although there are some exceptions with currency pairs such as those that include the Japanese Yen i.e. the USD/JPY. Such pairs go up to 2 decimal places. In such cases, the pip value is calculated by considering the last decimal place. For instance, if the USD/JPY moves from 111.39 to 111.40, this represents a one pip movement.
It is however important to note that there are some Forex brokers that quote currency pairs outside the standard four and two decimal places. For instance, there are brokers that quote currency pairs in 5 and 3 decimal places. Such brokers quote fractional pips referred to as pipettes. A good example of one pipette move would be a GBP/USD move from 1.51543 to 1.51544.
Calculating pip value
Pips are very important in Forex trading because they are used to measure profitability. You make more money in Forex when you earn more pips. The opposite also applies i.e. you lose more money when you lose pips. Anytime your open a trade that goes against you, you lose pips. When calculating pips, it’s also important to understand the fact that the number of pips you make per trade is dictated by the lot size you choose.
For instance, if you buy the currency pair EUR/USD at 1.4000 and the currency pair rises in value to 1.4010, you have made 10 pips profit which translates to $10 profit if you are trading with mini lots. When trading with standard lots, this translates to $100 profit since the 1 pip represents $10 when trading with standard lots.
A standard lot can be defined as a lot that equals the trade size. A standard lot equals 100,000 units of the quote currency (the 2nd currency quoted in any currency pair). A mini lot equals to 10,000 units of the quote currency while a micro and nano lot represent 1,000 and 100 units of the quote currency respectively. The higher the lot size, the higher the pip value and vice versa.
It’s important to note that the value of a pip can vary depending on factors like the currency pair being traded. For instance, some currency pairs have a stronger pip value than others. The pip value also varies depending on the size of a trade as well as the exchange rate. The pip value, in regards to the base currency, is calculated as the change in value of a counter currency multiplied by the exchange rate ratio.
The above information summarises the basics of pips in Forex trading. Although Forex brokers usually calculate the number of pips as well as the corresponding pip value automatically for their clients, it’s important to be able to understand what pips are and how they are calculated.