What is a Pip in Forex trading? Definition and examples.
This article will focus on the minimum price change known as pip. You will find out how much it is, why we measure price movements in them and whether the pip is the same for all trading instruments. What can I say – there are pips and then there are other pips, and it’s important to understand the pips meaning.
Pip trading depends on many things, and a trader has to know what position size, basis point and pip move mean. Let’s try to find out!
The article covers the following subjects:
Pips Definition & Meaning Calculating Pip value Finding Pip value in the trading account Major currencies pips: Forex Pips and price movement What is a Pipette/Point? Cost of one point on Forex Pips FAQ.
Pips Definition & Meaning.
I will not torment the reader with a long introduction. A pip is a general term for the minimum unit of price change. The term is mostly popular among Forex traders because it’s inconvenient to calculate miniscule fluctuations of currencies in dollars or euros. It's easier to say that the price grew by 540 pips than 0.0054 euros, isn't it?
An important detail about the FX pip is that it depends on the accuracy of the price measurement. Some brokers offer 4-digit quotes – here the accuracy of price measurement is limited to ten thousandths. In this case, the change of the fifth decimal point in the EUR/USD price - for example, from 1.00000 to 1.00004 - will go unnoticed. A one-pip change for a 4-digit Forex broker will equal a 10 pip price change for a 5-digit quote.
Let us consider the spread for the EUR/USD currency pair.
The exchange rate is 1.21232 to 1.21233:
the best sell price is EUR 1.21232, the best buy price is EUR 1.21233.
The spread, or the difference between the quotes, is EUR 0.00001 or 1 pip. As you have probably guessed, Litefinance provides 5-digit quotes.
Speaking about the minimum price move, let's analyze how the price of this instrument (EUR/USD) has changed during 5 minutes on a minute timeframe (M1).
The price is at the level of 1.21247.
After 10 minutes, the price increased slightly - to 1.21250.
The timeframe is small, that's why the growth is so small.
It turns out that the price has grown by 3 pips from 1.21247 to 1.21250 or by EUR 0.00003.
The pip value of 0.00001 is also called "fractional pip" because it is 1/10 of the “standard” value with a 4-digit quote.
Calculating Pip value.
To do this, we need to know:
the cost of 1 lot of the traded instrument. On Forex, it is usually 100,000 units of the base currency (which is the first in the quote). For example, the cost of 1 lot of the EUR/USD = 100,000 euros. The cost of 1 lot of the GBP/JPY = 100,000 pounds, etc. The cost of the instrument. Let's take EUR/USD again. At a rate of 1.20000, buying 1 lot (100,000 euros) will cost 100,000 x 1.20 = 120,000 dollars.
If we sell 1 lot at a price 1 pip higher, i.e. by 1.20001, as a result of such a trading operation we get 100,000 x 1.20001 = 120,001 US dollar. Therefore, we can earn 1 dollar on a move of one pip, which is the cost of one pip on this instrument.
Other instruments are calculated using the same method.
Let’s take the USD/JPY as an example of unconventional 3 decimal digits in the exchange rate calculation.
Cost of 1 lot - USD 100,000.
We’ll assume the rate of the instrument is 105.300.
In the example with the dollar and the yen, the minimum price fluctuation would be 0.001.
When buying 1 lot of the USD/JPY, you need 100,000 * 105,300 = 10,530,000 Japanese yen.
If the rate rises by one pip to 105.301, then 1 lot (100,000 US dollars) can be sold at 10,530,100 yen.
Therefore, the value of one pip here will be 10,530,100 - 10,530,000 = 100 yen.
Finding Pip value in the trading account.
Some of the values for calculating pip value on the Forex market can be found in the trading account. Let's open a chart of the EUR/USD currency pair in the online terminal. To do this, select the "currencies" tab and click on the EUR/USD pair.
The scale in the right corner of the chart shows the current price of the instrument. It sits at a value of $1.20241.
We have a 5-digit quote, which means that the minimum price change for this instrument will be $0.00001.
To calculate the value of one pip, you also need to know the volume of the transaction, which is measured in lots. The selected volume value is shown to the right of the chart:
As the volume of the transaction grows, the value of one pip for the trader also increases. As we found out earlier, with a volume of 1 lot, the cost of a pip is $1. This means that with a minimum volume of 0.01 lot, the cost of a pip will be equal to $ 0.01. In this case, the trader will be able to earn $0.5 on the price movement of 50 pips.
If you increase the volume to 0.1, the cost of 1 pip will also increase 10 times - from $0.01 to $0.1. Then the same movement of 50 pips can bring the trader $5.
It is crucial to understand that any trade always has two potential outcomes. So before playing with volumes, it is recommended that the trader should acquire basic knowledge of risk and money management.
Major currencies pips: Forex.
The major currency pairs are called the Majors. These include:
EUR/USD (Euro - US Dollar) USD/CHF (US dollar - Swiss franc) GBP/USD (British Pound - US Dollar) USD/JPY (US Dollar - Japanese Yen) USD/CAD (US Dollar - Canadian Dollar) AUD/USD (Australian dollar - US dollar) NZD/USD (New Zealand Dollar - US Dollar)
All these instruments have 5-digit quotes, except for the USD/JPY, which has 3 decimal places.
The cost of 1 lot for each instrument is 100,000 units of the base (first in the quote) currency: