Forex pip values are an essential aspect of forex trading. Understanding how to calculate them is necessary for traders to determine their profits and losses. In this article, we will discuss what forex pip values are and how to work them out.
What is a pip?
A pip, also known as a point, is the smallest unit of measurement in forex trading. It is the fourth decimal place in currency pairs that are quoted in four decimal places, such as EUR/USD. However, in currency pairs that are quoted in two decimal places, such as USD/JPY, a pip is the second decimal place.
For example, if the EUR/USD price moves from 1.1250 to 1.1251, this is a one-pip movement. Similarly, if the USD/JPY price moves from 109.00 to 109.01, this is a one-pip movement.
What is a pip value?
A pip value is the monetary value of a pip. It varies depending on the currency pair being traded and the size of the trade. It is essential to know the pip value to understand the potential profit or loss of a trade.
How to calculate pip values?
To calculate pip values, traders need to know three things: the currency pair being traded, the size of the trade, and the exchange rate.
The formula to calculate pip values is:
Pip Value = (Pip in decimal places x Trade Size) / Exchange Rate
Let’s break down the formula and understand each component:
1. Pip in decimal places: This is the number of pips that the price has moved. It is calculated by subtracting the opening price from the closing price and multiplying it by the pip factor, which is 0.0001 for most currency pairs.
For example, if the EUR/USD price moves from 1.1250 to 1.1251, this is a one-pip movement. To calculate the pip in decimal places, we subtract the opening price from the closing price:
1.1251 – 1.1250 = 0.0001
2. Trade Size: This is the size of the trade in lots. A lot is a standard unit of measurement in forex trading and is equal to 100,000 units of the base currency.
For example, if a trader buys 1 lot of EUR/USD, they are buying 100,000 euros.
3. Exchange Rate: This is the current exchange rate of the currency pair being traded.
For example, if the current exchange rate of EUR/USD is 1.1250, it means that one euro is equal to 1.1250 US dollars.
Now, let’s put it all together and calculate the pip value for a trade.
A trader buys 1 lot of EUR/USD at an exchange rate of 1.1250 and sells it at an exchange rate of 1.1260. What is the pip value?
Pip in decimal places = (1.1260 – 1.1250) x 0.0001 = 0.0001
Trade Size = 1 lot
Exchange Rate = 1.1250
Pip Value = (0.0001 x 100,000) / 1.1250 = $8.89
Therefore, the pip value for this trade is $8.89. If the trader had bought 2 lots, the pip value would have been $17.78.
Calculating forex pip values is a crucial skill for traders. It helps them to determine their potential profits and losses and manage their risk effectively. By understanding the formula and the components involved, traders can calculate pip values quickly and accurately.