Forex what is a pip 2

What is a Pip in Forex?

The value of each currency is quoted in the huge foreign exchange or forex market relative to that of a paired currency. This system arises because all transactions in the spot forex market involve simultaneously buying one currency and selling another in a currency pair at a market-determined exchange rate.

A key element of forex trading jargon that aspiring forex traders generally need to know about is something called a pip. Accordingly, most courses on forex trading will include a section about what a pip is in forex trading. If you’re new to forex trading and have wondered about pip meaning and pip values, then read on for a detailed discussion of these topics below.

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Table of Contents [ Show ]

What is a Pip? How Do You Use a Pip? How to Calculate the Value of a Pip Pips and Profitability Example Getting a True Understanding of a Pip in Forex Start Pip Trading with These Top FX Brokers Frequently Asked Questions.

What is a Pip?

The jargon term pip arose as an acronym meaning “percentage in point” since a pip is the equivalent of 1/100 of 1% or one basis point. The cash value of a pip or the pip value can differ among forex currency pairs and is based on exchange rate levels in some cases.

In practice, a pip in forex represents the minimum incremental change in a currency pair’s exchange rate based on the forex market’s convention. Forex traders also typically measure the bid/offer spread of currency pairs and their trading gains or losses in pips.

The exchange rates for most currency pairs are quoted out to four decimal places, so the smallest incremental change is in the fourth decimal point or 0.0001. For some currency pairs, such as those that include the Japanese yen that has an unusually low value, a change of one pip occurs in the second decimal point or 0.01.

How Do You Use a Pip?

Forex traders might use pips to quickly compute the amount gained or lost on a trade by taking the difference between the entry and exit exchange rates and multiplying by 10,000. Although profits and losses can also be expressed as an amount of money, that is a more complicated calculation that depends on the amount traded and also possibly an exchange rate.

Reporting trading results in pip amounts can make the most sense for a trader because of its simplicity. Trade results reported in pips can also be more easily compared across different currency pairs and position sizes.

Forex brokers and market makers typically do not charge transaction fees or commissions, although they do quote a bid/offer dealing spread that varies in width among the different currency pairs depending on their liquidity and the competitiveness of the quoting party.

As an example of a dealing spread, a quote obtained from a forex broker of 1.0700/05 for the GBP/USD currency pair is 5 pips wide. That same quote also implies that the broker is simultaneously prepared to buy GBP and sell USD at 1.0700 and to sell GBP and buy USD at 1.7005.

The dealing spread can be used to compare the quality of forex quotes obtained from different brokers. The difference between the bid and offer exchange rates in the dealing spread is commonly expressed in pips. Forex brokers and financial institutions looking to make more money off their clients might increase the bid/offer spread.

If you are a client of a forex broker, then the bid shown to the left in an exchange rate quote is the best exchange rate where you can sell the base currency of a particular currency pair to that broker. The offer exchange rate shown to the right is the best rate at which you can buy the base currency in that pair from the broker.

In a relatively recent development, some brokers also allow fractions of pips to be quoted in highly liquid currency pairs. As a case in point, the dealing spread for the EU’s euro quoted versus the U.S. dollar (EUR/USD) can often be less than a pip, especially if the quote is obtained by merging the best rates obtained from multiple liquidity providers.

How to Calculate the Value of a Pip.

To calculate the cash value of a pip, or the pip value, you first need to know the size of the trade, which is often measured in lots that can have different sizes. At most forex brokers, standard lots consist of 100,000 base currency units, while mini lots have 10,000 units, micro lots have 1,000 units and nano lots consist of only 100 base currency units.

The method for calculating the pip value in U.S. dollars also varies depending on whether the USD is the base currency or the counter currency in the currency pair.

When the U.S. dollar is the counter currency, as in the EUR/USD, GBP/USD, AUD/USD and NZD/USD pairs, the value of a pip or a 0.0001 movement in the exchange rate for a position of one standard-sized lot of 100,000 base currency units is always 0.0001 x 100,000 = $10. For such pairs, the pip value of a mini lot is $1, while that of a micro lot is $0.1 and a nano lot is $0.01.

For currency pairs that have the U.S. dollar as the base currency, such as the USD/JPY, USD/CHF and USD/CAD currency pairs, the current exchange rate must be used to calculate the cash value of a pip. This factor complicates matters somewhat since the pip value in U.S. dollars changes based on the exchange rate level.

For example, if the prevailing USD/JPY exchange rate is 144.65, and you are trading a standard lot of 100,000 base currency units, the value of a pip is 100,000 x 0.01/144.65 = $6.913. For a mini-lot of 10,000 base currency units, the pip value is 10,000 x 0.01/144.65 = $0.6912 and for a mico-lot, the pip value is 1,000 x 0.01/144.65 = $0.0691.

If the exchange rate dropped significantly to 120.00, then using the previous formula, 100,000 x 0.01/120.00 would yield a higher pip value of $8.333 instead of a pip value of $6.913 when the USD/JPY exchange rate was 144.65. If the exchange rate were to rally to 165.00, then the pip value would decline to $6.061.

As you can see, the exchange rate plays a significant role in the calculation of pip values when the U.S. dollar serves as the base currency in a pair.

Pips and Profitability Example.

Many traders use pips as a simple way to quantify their trading gains or losses. As an example of this, consider the case of a trader who purchased 100,000 euros and simultaneously sold $95,000 at a EUR/USD exchange rate of 0.9500.

If the EUR/USD exchange rate increased from 0.9500 to 1.0200, then that represents a profitable rise of 700 pips. The value of the trader’s 100,000 euro position would then have risen to $102,000 in U.S. dollar terms, netting them a tidy gain of $7,000.

Conversely, if the EUR/USD exchange rate declined to 0.8900, then their 100,000 euro position would have lost them (0.9500-0.8900) x 10,000 = 600 pips. Their long position would then only be worth $89,000, and so it would have lost $6,000 of value in U.S. dollar terms.

Getting a True Understanding of a Pip in Forex.

A pip is very useful as a measure of exchange rate movement for currency pairs. It allows you to compare trades in any currency pair, and a trade can be compared regardless of its trade size or the exchange rate of the currency pair involved.

Indicators based on pips like the ATR can also help you evaluate the risk involved in trading a currency pair. You’ll also get important information from the ATR about a pair’s volatility and trading range. It can be cumbersome to manually calculate the value of a pip, so most online brokers offer web-based pip calculators that simplify the process for you.

Start Pip Trading with These Top FX Brokers.

Benzinga has taken some of the guesswork out of selecting the best online forex broker to open an account by providing the shortlist of brokers displayed in the comparison table below.