What is Pips in Forex Trading? A Beginner's Guide

If you are new to forex trading, you might have heard the term “pip” and wondered what it means. In this article, we will explain what is a pip in forex, how it is used to measure currency price movements, and how to calculate pip values for different currency pairs. We will also provide some practical examples and applications of pips in forex trading.

What is Pips in Forex Trading?

A pip is an acronym for “percentage in point” or “price interest point”. It is the smallest unit of change in the exchange rate of a currency pair. For most currency pairs, a pip is equal to 0.0001, or one-hundredth of a percent. For example, if the EUR/USD exchange rate changes from 1.1800 to 1.1801, it means that it has moved by one pip.

Pips are important because they allow traders to quantify the profit or loss of their trades. By multiplying the number of pips by the size of the trade, you can calculate how much money you have made or lost in a given trade.

For example, if you buy 10,000 units of EUR/USD at 1.1800 and sell them at 1.1850, you have made a profit of 50 pips, or $50 (10,000 x 0.0001 x 5).

Pips are also used to indicate the spread, or the difference between the bid and ask prices of a currency pair. The spread is the cost of trading, as it represents the fee that the broker charges for executing the trade. The lower the spread, the cheaper the trade.

For example, if the bid price of EUR/USD is 1.1798 and the ask price is 1.1800, the spread is 2 pips.

To learn more, you can visit this link that explains what is a pip in forex in detail.

What is a Pipette?

A pipette is a fractional pip, or one-tenth of a pip. It is the fifth decimal place in the exchange rate of a currency pair. For example, if the EUR/USD exchange rate changes from 1.18000 to 1.18005, it means that it has moved by 5 pipettes, or half a pip. Pipettes are used to provide more precision and accuracy in the measurement of currency price movements.

Exploring the Concept of Pips in Forex

The concept of pips in forex trading is based on the idea that the value of a currency is relative to another currency. Therefore, the exchange rate of a currency pair reflects the ratio of the values of the two currencies.

For example, the EUR/USD exchange rate of 1.1800 means that one euro is worth 1.18 US dollars.

The exchange rate of a currency pair can change due to various factors, such as supply and demand, interest rates, inflation, political events, and market sentiment. These factors affect the value of each currency relative to the other, and thus cause the exchange rate to fluctuate. The fluctuation of the exchange rate is measured in pips, which represent the change in the ratio of the values of the two currencies.

The relationship between pips and currency pairs is also influenced by the base and quote currencies. The base currency is the first currency in the pair, and the quote currency is the second currency in the pair. The exchange rate of a currency pair shows how much of the quote currency is needed to buy one unit of the base currency.

For example, the EUR/USD exchange rate of 1.1800 means that one euro can buy 1.18 US dollars.

The base currency is also the currency that the pip value is expressed in. The pip value is the amount of money that a pip represents in the base currency.

For example, the pip value of EUR/USD is 0.0001 euros, or 0.0001 x 1 = 0.0001 euros. The pip value of USD/JPY is 0.0001 US dollars, or 0.0001 x 1 = 0.0001 US dollars.

Calculating Pip Values

To calculate the pip value of a currency pair, we need to know the size of the trade, the exchange rate, and the conversion rate. The size of the trade is the number of units of the base currency that are traded. The exchange rate is the current price of the currency pair. The conversion rate is the rate that converts the pip value from the base currency to the account currency, which is the currency that the trader uses to fund their account.

The formula for calculating the pip value is

Pip value = (size of the trade x exchange rate x pip) / conversion rate

For example, if a trader buys 10,000 units of EUR/USD at 1.1800, and their account currency is US dollars, the pip value is:

Pip value = (10,000 x 1.1800 x 0.0001) / 1

Pip value = $0.118

This means that for every pip that the EUR/USD exchange rate moves in the trader’s favor, they will make $0.118 in profit. Vice versa, for every pip that the EUR/USD exchange rate moves against the trader, they will lose $0.118.

Practical Examples and Applications

To illustrate the concept of pips in forex trading, let us look at some practical examples and applications.

Example 1: A trader buys 10,000 units of EUR/USD at 1.1800 and sells them at 1.1850. How much profit or loss did they make in pips and in US dollars?

The trader made a profit of 50 pips, or 0.0050 in the exchange rate. To calculate the profit in US dollars, we need to multiply the number of pips by the pip value:

Profit = 50 x $0.118

Profit = $5.90

Example 2: A trader sells 20,000 units of USD/JPY at 110.00 and buys them back at 109.50. How much profit or loss did they make in pips and in US dollars?

The trader made a profit of 50 pips, or 0.50 in the exchange rate. To calculate the profit in US dollars, we need to multiply the number of pips by the pip value:

Profit = 50 x $0.1818

Profit = $9.09

The pip value of USD/JPY is $0.1818, which is calculated as:

Pip value = (20,000 x 110.00 x 0.0001) / 1

Pip value = $0.1818

Example 3: A trader buys 50,000 units of GBP/USD at 1.3900 and sells them at 1.4000. How much profit or loss did they make in pips and in US dollars?

The trader made a profit of 100 pips, or 0.0100 in the exchange rate. To calculate the profit in US dollars, we need to multiply the number of pips by the pip value:

Profit = 100 x $0.3571

Profit = $35.71

The pip value of GBP/USD is $0.3571, which is calculated as:

Pip value = (50,000 x 1.3900 x 0.0001) / 1

Pip value = $0.3571

Conclusion

Pips are a fundamental concept in forex trading, as they allow traders to measure the change in the exchange rate of a currency pair, and to calculate the profit or loss of their trades. Pips are also used to indicate the spread, or the cost of trading. Pips are usually equal to 0.0001, or one-hundredth of a percent, for most currency pairs, except for those that involve the Japanese yen, where a pip is equal to 0.01, or one percent. Pips can be further divided into pipettes, which are one-tenth of a pip, or the fifth decimal place in the exchange rate. The pip value of a currency pair depends on the size of the trade, the exchange rate, and the conversion rate.

By knowing how to calculate the pip value, you can determine how much money you can make or lose for every pip movement in the exchange rate. Pips are essential for successful forex trading, as they help you manage risk and reward.