If you’ve ever had a conversation with a forex trader, the word “pip” has probably come up. Most often, you’ll hear how many pips a currency has moved or how many pips the trader has gained or lost in a trade or with a particular trading strategy.
If you’re a new forex trader, your conversation can run the gamut from interesting to pretty confusing. No worries. Benzinga will help smooth out your “pip” knowledge.
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What is a Pip?
A pip is short for “percentage in point.” It’s the smallest measure of change for a currency pair and it is not the same for all currency pairs. A change of a pip for most currency pairs is measured in four decimal points (0.0001), but you can also find currency pairs where a change of a pip is a change of 0.01.
How Do You Use a Pip?
To show how much they’ve gained or lost in a trade, forex traders use pips. The profit you make on a trade can be expressed in the amount of money you’ve made, but that depends a lot on the size of a trade and other factors. You can use different lot sizes in forex trading, which makes trades harder to compare. With pips, it is much easier to compare trades across the currency pairs and lot sizes.
There are many forex trading strategies based on a price movement. Some traders might decide to open a short position if the currency pair makes a sudden move lower. In this strategy, the size of the move would be defined by the number of pips the currency pair has lost over the observed time frame.
You could also measure a typical move for a currency pair by calculating the average true range (ATR) indicator. Its value is presented in pips and it shows a range of a movement for a currency pair in the chosen period and time frame. With the indicator, you can get valuable historical volatility information that can help you in setting up your risk management strategy.
Forex brokers don’t charge trading fees, but they have bid-ask spreads. The bid-ask spread is the difference between the best bid price and the best ask price and it is expressed in pips. Brokers who want to make more money per trade will increase the spread. For a very liquid currency pair, the spread can be less than a pip. This is possible if you are trading with brokers that allow fractional pips.
How to Calculate the Value of a Pip
First, know that the amount of money you can gain or lose with a change of one pip in a currency pair depends on the size of your trade. The standard lots are 100,000 units, 10,000 units, 1,000 units, and 100 units.
In the following examples, you can find pip value calculations for the account with the U.S. dollar as the base currency. The calculation differs if the USD comes first or second in the name of the currency pair you’re trading.
If you’re trading the USD/JPY currency pair and use 100,000 units, a change of 1 pip would mean a change of $8.85. For 10,000 units, it would mean a change of $0.89.
To calculate the U.S. dollar value of a pip for the USD/JPY trade, divide 0.01 by the current exchange rate of the USD/JPY currency pair, which is 112.95. Then multiply by the lot size. The math looks like this: 100,000 x (0.01/112.95) = $8.85.
You can see that the exchange rate plays an important part in the calculation. Let’s see what happens if the exchange rate changes significantly. What is the value of 1 pip if the USD/JPY currency pair drops to 95? Using our formula, 100,000 x (0.01/95), the answer is $10.53. If it jumps to 130, the result changes to $7.69.
For the USD/CHF currency pair, a change of 1 pip would be a change of 0.0001. The value of a pip for the current exchange rate of 0.9974 is $10.03, for a lot of 100,000 units.
When you trade currency pairs like GBP/USD or EUR/USD, the value of a pip is $10 for a lot of 100,000 units. To buy 100,000 euros, you need $113,360 USD, at the current currency rate of 1,1336. If it changes to 1,1337, you’ll gain $10.
Final Thoughts
A pip is very useful as a measure of the move for currency pairs. It allows you to compare trades in any currency pair, and a trade can be compared regardless of trade size or the exchange rate of the currency pair you’re trading. It can also help you to evaluate the risk for the currency pair.
You’ll also get important information about its volatility and trading range. It can be cumbersome to manually calculate the value of a pip, so most brokers have pip calculators that simplify the process for you.
