What is pip in forex trading explained
6 min read
If you are interested in the Forex market, you have probably come across the terms “pip” or “point”, which are very common concepts in trading.
The Forex exchange is a complex financial and economic tool that requires a precise understanding of basic terms and concepts. It so happens that specific terminology has become a constant companion to exchange operations, allowing for quick exchange of information without detailed explanations of standard parameters, processes, and phenomena. What are pips and points on the Forex market? Clear answers to these questions are necessary, otherwise, any operation may result in a loss due to a trivial reason.
Learning the forex trader profession has many similarities to learning mathematics, which is based on rules and axioms. From simple to complex – this is the only possible way that will allow you to succeed in this promising field. And for this, you will have to learn and remember a certain number of terms that help in daily work.
The set includes two important concepts, such as “points” and “pips”, which, in essence, are related parameters. With this inseparable pair, traders face practically every minute, so the detailed description below with examples will undoubtedly be useful to all newbies.
In this article, we will take a detailed look at what a point and pip are in Forex trading, how useful this concept is for Forex trading, and how to calculate a point.
What is pips in forex?
The thing is, in this market, the value of currencies is determined up to the fourth decimal point. Consequently, pip is the fourth digit after the decimal point, the change of which is the smallest fluctuation of quotes.
A simple example can be seen in the course of the most popular currency pair USD/EUR. If the value of this tandem fell from 1.200 to 1.1150, professional traders say: “The price has changed by 50 pips.” Many traders try to earn small amounts on short deals predicting such changes. If the quote increases or decreases by more than 100 pips, such a non-standard situation is denoted by the term “Big figure.” Despite its seeming insignificance, even such a small value as 1 pip is fully compensated in large deals with lot sizes of 1 and more with a positive order closure.
It should be noted separately that for currency pairs with the Japanese currency Yen (JPY), 1 pip corresponds to the second digit after the decimal point. This layout is associated with a two-digit rate of this currency against the US dollar (1 USD = 111.4 JPY in July 2017).
So, 1 pip equals 0.0001, and in participation in trading with the Japanese yen, it is 0.01. If five digits after the decimal point are used to determine the quote, then an increase in one point will be equal to 10 pips.
What is a point?
A point is a direct “relative” of the pip but describes changes in quotes to the left of the decimal point. Since this is a larger parameter, the term “point” is mainly used in stock markets where stocks are traded. That is, if the value of securities fell from $120 to $115, we say that the cost has changed by 5 points. In this segment, there is another popular parameter – “tick”, which is equal to 1/10 of a point. In the above example, the value of shares would have changed by 50 ticks.
In the Forex market where thousands and hundreds of decimal places are usually discussed, the concepts of “pip” and “point” are identical.
Importance of pip in forex trading
The main function of the pip parameter is to allow traders to quickly assess their profit or loss. It is important to be able to convert 1 pip into a monetary equivalent in order to see the specific amount earned or lost. Special formulas are used to calculate the value of 1 pip, which are provided in the next section of our article.
Calculating pip value
There are several methods for calculating the value of pip:
- Calculation based on contract size: 1 pip = 0.0001 * contract size. For example, when trading the currency pair EUR/USD with a contract size of 100,000 units, 1 pip would be equal to 10 dollars (0.0001 x 100,000).
- Calculation based on rate and number of lots: 1 pip = (price change * number of lots) / current rate. For example, if you open a trade on EUR/USD and the pair’s rate is 1.1200 and you buy 1 lot (100,000 units), and the price rises by 15 points to a rate of 1.1215, then the price change would be 0.0015 dollars (1.1215 – 1.1200). Therefore, 1 pip would be equal to (0.0015 x 1) / 1.1200 = 0.0000134 dollars.
- Calculation based on spread size: 1 pip = (spread size * 10) / rate. For example, if the spread on EUR/USD is 1 point and the rate is 1.1200, then 1 pip would be equal to (1 * 10) / 1.1200 = 0.0893 cents.
Example of calculation with two-digit quotes
The most famous currency in this case is the Japanese yen. Currency pairs that include yen are quoted to three decimal places, so a pip for such pairs is calculated to the second decimal place.
Let’s take a look at how pips are calculated using the USD/JPY currency pair as an example. If you sell one lot of USD/JPY, a one pip decrease in price will help you earn 1000 yen.
Let’s consider an example of calculating pips to understand why.
Suppose you sell 2 lots of USD/JPY at a price of 113.407. One lot of USD/JPY is worth $100,000. Therefore, you sell 2 x $100,000 = $200,000 to buy 2 x $100,000 x 113.407 = 22,681,400 yen.
Now, imagine that the price moves against you and you decided to reduce your losses. You closed the position at a price of 113.907, which rose 50 pips against you from 113.407.
So, you closed your position by buying 2 lots of USD/JPY at 113.907, i.e. 2 x $100,000 x 113.907 = 22,781,400 yen. This is 100,000 yen more than your initial amount that was required to open the short position, so at the moment, you have a loss of 100,000 yen on your account.
A loss of 100,000 yen due to a 50 pips movement means that you lost 100,000/50 = 2,000 yen for every pip. Since you sold two lots, the value of one pip is 1,000 yen per lot.
Example of calculation with four-digit quotes
Suppose you want to trade one of the main currency pairs – EUR/USD – and have decided to buy one lot.
One lot costs 100,000 euros. In the case of EUR/USD, one pip is 0.0001. Thus, the value of one pip for one lot is 100,000 x 0.0001 = $10. That is, if the price changes by one pip, your profit or loss will be $10.
Suppose you buy EUR/USD at a price of 1.16650, and then close your position by selling one lot at a price of 1.16660. The difference between these two will be:
1.16660 – 1.16650 = 0.00010
In other words, the difference is 1 pip. Your profit will be $10.
You have opened a position at a price of 1.16650, buying one contract. This is equivalent to buying 100,000 euros. That is, you are selling dollars to buy euros. The value of the dollars you are selling is determined by the exchange rate:
100,000 euros x 1.16650 = $116,650
After buying one lot, you closed your position by selling one contract at a price of 1.16660. Now you are selling euros and buying dollars:
100,000 euros x 1.16660 = $116,660
This means that you initially sold $116,650, and in the end received $116,660, that is, your profit was $10. From this example, it can be seen that a movement of one pip in your favor brought you $10.
One pip is equal to 10 units of the quote currency (that is, the currency standing in second place in the pair), if we are talking about a position of one lot (which is always equal to 100,000 units of the base currency – the currency standing in first place in the pair).
A movement of 10 pips is worth 100 units of the quote currency. A movement of 100 pips is worth 1,000 units of the quote currency, and so on.
Conclusion
Understanding the significance of pips and points in conducting transactions on the Forex currency market allows a novice trader to accurately assess their profits and losses from the first stages. Even with small deposits calculated on minor changes in pips, such orders can generate income. The first earned money is a crucial moment for any beginner. We hope that our article has helped you understand the essence, functions, and possibilities of these simple but very important concepts of currency transactions.
