Forex trading involves buying and selling currency pairs with the aim of making a profit. In order to make informed trading decisions, traders need to be able to calculate the value of each pip in their trades. A pip is a unit of measurement that represents the smallest amount by which a currency pair can change in value. In this article, we will explain how to calculate pips in forex.
What is a pip?
A pip is short for “percentage in point” and is the smallest price movement in a currency pair. It is usually the fourth decimal place in a currency pair, except for pairs that include the Japanese yen, where it is the second decimal place.
For example, in the EUR/USD currency pair, if the price moves from 1.1000 to 1.1001, that is a one pip movement. In the USD/JPY currency pair, if the price moves from 105.00 to 105.01, that is also a one pip movement.
Calculating the value of a pip
To calculate the value of a pip, you need to know three things:
1. The currency pair you are trading
2. The size of your trade in lots
3. The exchange rate of the currency pair
Once you have this information, you can use the following formula to calculate the value of a pip:
Value of a pip = (pip in decimal places * trade size * exchange rate) / exchange rate of the account currency
Let’s break this formula down further:
Pip in decimal places: This is the number of decimal places in the currency pair that represents one pip. For most currency pairs, this is four decimal places. However, for currency pairs that include the Japanese yen, this is two decimal places.
Trade size: This is the size of your trade in lots. A lot is the standard unit of measurement in forex trading and represents 100,000 units of the base currency.
Exchange rate: This is the exchange rate of the currency pair at the time of the trade.
Exchange rate of the account currency: This is the exchange rate of your account currency to the currency in the currency pair you are trading. For example, if you are trading the EUR/USD currency pair and your account is in USD, the exchange rate of the account currency would be 1.
Let’s look at an example to see how this formula works in practice.
Example:
Suppose you are trading the EUR/USD currency pair and you have a trade size of 1 lot. The exchange rate at the time of the trade is 1.1000. You are trading from a USD account.
The pip value in this case would be:
Value of a pip = (0.0001 * 100,000 * 1.1000) / 1
Value of a pip = $10
This means that for every one pip movement in the EUR/USD currency pair, your profit or loss would be $10.
Calculating profit and loss
Now that you know how to calculate the value of a pip, you can use this information to calculate your profit or loss on a trade.
To calculate your profit or loss, you need to know the number of pips you gained or lost in the trade and the value of each pip.
Suppose you bought 1 lot of the EUR/USD currency pair at 1.1000 and sold it at 1.1100, making a profit of 100 pips. Using the pip value we calculated earlier, your profit would be:
Profit = (100 pips * $10 per pip) = $1,000
Conversely, if you had sold the EUR/USD currency pair at 1.1000 and bought it back at 1.0900, making a loss of 100 pips, your loss would be:
Loss = (100 pips * $10 per pip) = $1,000
Conclusion
Calculating pips in forex is an essential skill for traders to have. By knowing the value of a pip, traders can make better-informed trading decisions and manage their risk more effectively. Remember to always check the pip value before entering a trade, and keep in mind that the value of a pip can vary depending on the size of your trade and the exchange rate of the currency pair.
