Understanding the Place of Pips in Forex Trading

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Understanding the Place of Pips in Forex Trading

The concept of PIP in Forex is a basic one but its understanding and recognizing its importance will make any Forex trader on the market formidable.  A Pip, which actually stands for Percentage in Point or Price interest is the unit of measure by which changes in the exchange rate of currencies are expressed. It is a price move in the exchange rate of a given currency based on Forex market convention. 

For example if GBP/USD moves from 1.2450 to 1.2451, the .0001 rise in value of the USD is one pip. 

The pip is usually the last number in the price quote in Forex. Most pairs are usually spread out to four decimal places. An exception to this is the Japanese Yen. Unlike the others, the Yen spreads out to only 2 decimal places so a pip for the JPY will be represented by a single digit change in the second decimal place in the forex quote. 

For example, if the price of USD/JPY moves from 1.14 to 1.15 this would be a one pip or ‘point’ movement.

There is another unit that can be found in a Forex pair. It is usually at the top of the quote in superscript. That is referred to as a pipette and it is a fraction of a pip, a one-tenth of a pip.

Having the ability to calculate the value of a pip helps traders to put a monetary value on their goals, especially their profit targets and stop loss levels. It is crucial to understand that the value of a pip will vary for the many currency pairs on the market. The value of a pip will be shown in the value of the quote currency hence why the difference in values of pip when trading with different currency pairs. Hence, if we are trading EUR/USD, the value of a pip will be expressed in USD and if it is CAD/JPY, it will be in JPY.

The monetary value of each pip depends on three factors: 

  1. The currency pair being traded 
  2. The size of the trade 
  3. The exchange rate.

Based on these factors, the fluctuation of even a single pip can have a significant impact on the value of the open position. Determining the monetary value of a pip is dependent on three factors: 

  • The currency pair that is traded
  • The size of the trade
  • The exchange rate.

The formula for calculating the value of one pip is simply:

Pip Value = Contract Size × A Pip (which is 0.0001, 0.01 for the Yen only)

Let’s say a trade was made on the market with the EUR/USD pair at a £10 million position which was closed at 1.1901 with a profit of 5 pips made on it. 

The value of the 5 pips made will be; £10 million × 0.0005 = $5,000

Remember, as previously stated, the value of the pip will always be expressed in the value of the quote currency. To calculate your profit in Euros, you will divide the profit by the exchange rate which according to this scenario is 1.1901. Thus, the profit will be; $5000/1.1901 = £4201.32.

With this understanding, it’ll be easier for you to start off as a trader even as you take cognizance of all other criteria mentioned in the guide.