Forex trading is a complex and dynamic process that requires traders to have a good understanding of the different terminologies and concepts involved. One of these concepts is the pip, which is an essential component in forex trading. In this article, we will discuss what a pip is and how to compute it in forex trading.
What is a pip?
A pip, also known as a point, is the smallest unit of measurement in the forex market. It is used to measure the price movement of a currency pair. In most currency pairs, the value of a pip is equivalent to 0.0001 or 1/100th of a cent. However, in some currency pairs, the value of a pip may be different. For instance, in currency pairs that involve the Japanese yen, the value of a pip is equivalent to 0.01 or 1/100th of a yen.
Why is pip important in forex trading?
Pip is important in forex trading because it helps traders to determine the profit or loss they have made on a trade. For instance, if a trader buys a currency pair at 1.2000 and sells it at 1.2050, the price has moved by 50 pips. If the trader had bought 10,000 units of the currency pair, the profit made would be 50 pips x $1 (the value of a pip in this case) x 10,000 units, which is $500.
How to compute pip in forex trading?
The computation of pip in forex trading depends on the currency pair being traded and the size of the trade. To compute pip, you need to follow these steps:
Step 1: Determine the currency pair being traded
The first step in computing pip is to determine the currency pair being traded. For instance, if you are trading the EUR/USD currency pair, you need to know that the value of a pip is 0.0001 or 1/100th of a cent.
Step 2: Determine the size of the trade
The second step in computing pip is to determine the size of the trade. This refers to the number of units of the currency pair being traded. For instance, if you are trading 10,000 units of the EUR/USD currency pair, the size of the trade would be 10,000 units.
Step 3: Compute the value of a pip
The third step in computing pip is to compute the value of a pip. This is done by multiplying the value of a pip by the size of the trade. For instance, if you are trading the EUR/USD currency pair and the size of the trade is 10,000 units, the value of a pip would be $1. This is computed as follows:
Value of a pip = (0.0001 / exchange rate) x size of the trade
= (0.0001 / 1.2000) x 10,000 units
= $0.8333
Step 4: Determine the profit or loss
The fourth step in computing pip is to determine the profit or loss made on a trade. This is done by multiplying the number of pips by the value of a pip and the size of the trade. For instance, if you bought the EUR/USD currency pair at 1.2000 and sold it at 1.2050, the price has moved by 50 pips. If the size of the trade is 10,000 units and the value of a pip is $0.8333, the profit made would be:
Profit = number of pips x value of a pip x size of the trade
= 50 pips x $0.8333 x 10,000 units
= $41.67
Conclusion
Pip is an essential component in forex trading as it helps traders to determine the profit or loss made on a trade. The computation of pip depends on the currency pair being traded and the size of the trade. By following the steps outlined in this article, traders can compute pip accurately, which can help them make informed trading decisions.
