In the world of Forex trading, do not be surprise to come across several terms that might sound similar but are totally different in meaning from each other and a Pip is one of these terms.
A PIP is a fundamental term in the foreign exchange market. As a forex trader, you buy and sell a currency whose value is expressed in relation to another currency. Quotes for these forex pairs appear as bid and ask spreads that are accurate to four decimal places.
As for the introductory lesson in our Forex journey, I will explain what is Pip is and How to calculate a pip value in most currency pairs.
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What is a Pip?
A pip in forex is actually the smallest whole unit price move that an exchange rate can make, based on forex market convention. In simple mathematical terms, a pip can simply be referred to as one-hundredth of 1% (1/100 *0.01) and appears in the fourth decimal place.
Most of the currency pairs in the Forex market are priced out to four decimal places, and a single pips is in the fourth decimal place (meaning 1/10,000th). Like for example the smallest whole unit move the currency pair USDCAD can make is 0.0001 or simply 1 pip.
PIP, is just a short form for percentage in points.
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How to Calculate Pip Value
Before you we get started, it is good you have in mind that a pip's value depends on the currency pair, the exchange rate and the trade value. When your forex account is funded in with US dollars, and the USD is the second of the pair or the quote currency, like in the EURUSD pair, the pip is fixed at 0.0001.
In this case, the value of a single pip is simply calculated by multiplying the trade value or lot size by 0.001. So for the EURUSD pair, if we multiply a trade value of say 10,000 euros by 0.0001, the pip value is $1. This also means that if you decided to buy 10,000 euros against the dollar at price 1.0801 and sold at 1.0811, then you had make a profit of 10 pips which is equivalent to $10.
Trade Value (Pip Size /Exchange Rate) = Pip Value.
JPY Exception
Japanese Yen pairs make an exception here because they are quoted with two decimal places, marking a remarkable exception to the four decimal place rule. So for currency pair such as the EUR/JPY and USDJPY the value of a single pip is 1/100 divided by the exchange rate.
Pips and Profitability
The movement of the exchange rate of a currency pair is what actually determines whether a trader makes a profit or loss at the end of the day. A trader who decides to go long on the EURUSD will profit if the EUR appreciates in value relative to the U.S dollar. Provided that the trader entered a long position at 1.1835 and exited the trade at 1.1901, they would make 66 pips on the trade.
Another one is consider a trader who buys the Japanese Yen by selling the USD/JPY pair at 112.06. the trade goes up three pips (112.09) and the trader is losing but finally they are able to close the position at 112.01 and ends up with a 5 pips profit.
Though the differences might look small, gains add up very quickly in the forex industry especially depending on your Lot size of the trade.
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What is The Difference Between a Pip and a Pip and a Pipette?
As earlier said in this article, in the context of the foreign exchange market, a pip is a standard unit of measure for changes in an exchange rate, illustrating a move of 0.0001, which is actually the smallest price change increment for most currency pairs.
A pipette on the other hand equals 1/10 of a pip and represents a fraction of 1/100,000.
Therefore, a pip is in relation to movement in the fourth decimal place while a pipette is used to measure movement in the fifth decimal place.
Does The Japanese Yen Forex Rate Use Pips?
Though a little different from other pairs, it still does use pips. A quote for the yen normally extends two decimal places past the decimal point and so a single whole unit pip is 0.01 instead of the usual 0.0001 used in other currency pairs.
What is The Spread In Forex?
A spread in forex is referred to as the difference between the bid price and the ask price of a currency pair. Like for example, if EUR/USD has an ask price of 1.1053 and a bid price of 1.1051, then the spread is 0.0002 or simply 2 pips.
As a forex trader, you might some times think that the spread are negligible but it might be costly especially when you enter large trade positions. For example if you trade 100,000 units of EUR/USD with a 2-pip spread, then the cost of the spread is $20 (0.0002*100,00).
Closing Remark on What Are Pips?
Sure by now you already have a perfect understanding as far as the term pips in forex is concerned. A pip is a basic measure used in the forex market for currency movements. This is typically the smallest price move that a given exchange rate makes based on market convention.
Understanding pips is very essential for forex traders since it lets them quantify the value of their potential gains or losses and manage their leverage and risk accordingly and in all safety.