Forex trading is a complex and dynamic market, and one of the most important concepts in this world is the pip. A pip is a unit of measurement that is used to represent the smallest possible change in the value of a currency pair. In this article, we will explain what a pip is, how it is calculated, and how it is used in forex trading.
What is a pip?
A pip stands for “percentage in point” or “price interest point. It is the smallest unit of measurement in forex trading and represents the change in the exchange rate of a currency pair. Most currency pairs are quoted with four decimal places, with the exception of the Japanese yen pairs, which are quoted with two decimal places. In a currency pair quoted with four decimal places, one pip is equal to 0.0001, while in a currency pair quoted with two decimal places, one pip is equal to 0.01.
For example, let’s consider the EUR/USD currency pair, which is one of the most widely traded currency pairs in the forex market. If the exchange rate of this currency pair changes from 1.1300 to 1.1301, this means that the value of the euro has increased by one pip against the US dollar.
How is a pip calculated?
The calculation of a pip is straightforward. To calculate the value of one pip in a currency pair quoted with four decimal places, you need to divide 0.0001 by the exchange rate. For example, if the exchange rate of the EUR/USD currency pair is 1.1300, the value of one pip is:
0.0001 / 1.1300 = 0.00008850
This means that one pip in the EUR/USD currency pair is worth $0.00008850.
In a currency pair quoted with two decimal places, the calculation is slightly different. To calculate the value of one pip in a yen pair, you need to divide 0.01 by the exchange rate. For example, if the exchange rate of the USD/JPY currency pair is 105.25, the value of one pip is:
0.01 / 105.25 = 0.00009479
This means that one pip in the USD/JPY currency pair is worth ¥0.09479.
How is a pip used in forex trading?
Pips are an important concept in forex trading because they are used to calculate the profit or loss of a trade. When you open a position in a currency pair, you need to specify the number of lots you want to trade. A lot is a standard unit of measurement in forex trading and represents a specific amount of currency. One standard lot is equal to 100,000 units of the base currency.
When you open a position in a currency pair, the profit or loss of the trade is calculated based on the number of pips the exchange rate moves. For example, if you buy one standard lot of the EUR/USD currency pair at 1.1300 and close the trade when the exchange rate reaches 1.1400, you have made a profit of 100 pips. The value of the profit depends on the number of lots you traded and the value of one pip.
For example, if you traded one standard lot of the EUR/USD currency pair, the value of one pip is $10. Therefore, the profit of the trade is:
100 pips x $10 = $1,000
If you had traded two standard lots, the profit would be:
100 pips x $20 = $2,000
On the other hand, if the exchange rate had moved against you and you had closed the trade at 1.1200, you would have made a loss of 100 pips. The value of the loss depends on the number of lots you traded and the value of one pip.
For example, if you traded one standard lot of the EUR/USD currency pair, the value of one pip is $10. Therefore, the loss of the trade is:
100 pips x $10 = $1,000
If you had traded two standard lots, the loss would be:
100 pips x $20 = $2,000
Conclusion
Pips are an essential concept in forex trading and represent the smallest possible change in the value of a currency pair. They are used to calculate the profit or loss of a trade and are a crucial part of risk management. Understanding how pips work is essential for any trader who wants to succeed in the forex market. By using pips correctly, traders can make informed decisions about when to enter or exit a trade and can manage their risk effectively.
