If you are a forex trader, you probably have come across the term pip during your endeavor. What could be the term pip possibly mean? Read on this article and learn about pip and its relation to Forex Trading.
Definition of Pip
Pip is a short term for the point of percentage. This is an increment price movement related to a specific value that is dependent on the market in question. In simple terms, this is a standard unit used to measure how much an exchange rate has changed in its value.
Initially, the term pip was defined as the smallest increment in which a Forex price can move, but with the invention of precise pricing methods, the original definition does not hold its truth. It was also quoted in a set of decimals, most commonly four decimal places, and was usually a one-point movement in the final decimal place that has been quoted.
Nowadays, brokers quote Forex prices to an extra decimal in place, but this does not mean that Pip is not the final decimal place in a quote. It remains to be a standardized quote across different trading platforms and brokers, making it easy for traders to communicate different terms without confusion.
Calculating the Value of Pip
Before you proceed into knowing how to calculate a pip in Forex Trading, you need to know about a currency pair to learn how pip in Forex Trading is acquired.
Currency Pairs in Forex Trading
A currency pair is a quotation of two different currencies. For instance, in a EUR/USD currency pair, this represents a quotation between the Euro and the US dollar. The EUR represents the base currency, while the USD represents the quote currency. Therefore, the value of the quote currency represents how much you need to purchase the base currency.
With that in mind, you can now proceed into learning how to calculate the value of a pip.
As learned earlier, the value of a pip in Forex Trading in currencies pairs such as the EUR/USD is usually 0.0001. This means that the standard lot of 100,000 units in the base currency and for a mini lot, this entails 10,000 units. Therefore, in a EUR/USD currency pair, the value of one pip in a maximum lot is $ 10 based on 0.0001 x 100,000.
Please note, lots represents the amount of currency that a trader can use. The maximum lot equals 100,000, while the minimum lot represents 10,000.
How Does the Difference in Pip Value Come into Place?
In a typical Forex trade, there is buying and selling. Pip is determined by the value of the difference between the selling price and the buying price. It can either be a loss or a profit depending on your trade.
Conversion of Pip Value
Assume that you opened your position at 1.16650 and bought one contract that is worth 100,000 EUR. In this case, you will be selling dollars to buy Euros. The exchange rate dictates the value of the Dollars that you will be selling.
Therefore, with your 100 000 EUR, multiply with the position, and you will have $ 116,650.
Now let’s assume that the close of business the position is 1.16660, and you intend to sell your dollars. Therefore, with your 100,000 EUR, multiply with the current position and end up earning USD 116,660.
In this case, you would have exchanged $ 166,650 and ended up with $ 166,6660, which means that you have earned a profit of $10. Therefore, the movement of one pip (1.1660 – 1.16650 = 0.0001) has made a profit of $ 10.
The trading pip is usually consistent across most Forex pairs, and in most cases, the exchange rate is often 10 units of the quote price. If one is dealing with lots, the size of one lot, which is usually 100,000 of the base currency, a move of 10 Pips is worth 100 units of the quote currency.
Currencies without Four Decimals
As stated earlier, most of the currencies pairs such as the USD/EUR attracts a four decimal pip. However, there is an exception to the USD/JPY, which has two decimal place pip. Therefore, while calculating the value of such pip, it is always governed by the second decimal place.
Let’s work through an example:
- Suppose you want to sell one lot of USD/JPY currency at a pair of 113.607, with one lot worth 100.00. This means that you will be selling a USD 100,000 to purchase 100,000 x 113.607 = 11,360,700 JPY.
- If the market did not favor you and decided to sell at a close position of 114.107, it means that the price has moved by 0.50, meaning that you have earned 50 Pips.
- Therefore, you proceed into purchasing one lot (100,000 units) at the rate of 114.107, the price of your USD would be 100,000 x 114.107 = 11,410,700 JPY.
- This means that you will have 100,000 JPY, from your original sale, which translates to a shortfall.
- The 100,000 JPY that counts as your loss means that you have lost 1,000 JPY based on the 100,000/50.
Reasons why You Should Learn About Pips
The main reason behind learning Pips in Forex Trading is to determine whether it is dangerous to invest or not. Based on the market trends, you can end up losing huge amounts of investments if you invest heavily and lose a large number of Pips. In simple terms, this means that learning Pips will help you in limiting you from over-leveraging your account based on the size that you select.
There are lots of aspects to learn about Forex Trading. As a beginner, learning about Pips the basis of your trading. Therefore, it is recommended to keep yourself updated with information about Forex Trading to be sure of what you are about to venture into.