Forex trading is a complex market that requires a good understanding of various concepts and terminologies, including pips. Pips are a crucial aspect of forex trading as they help traders to determine profits or losses. In this article, we will delve into how pips are calculated in forex.
What are pips?
Pips, also known as points, are the smallest unit of measurement in forex trading. They represent the fourth decimal place in currency pairs, except for the Japanese yen pairs, which represent the second decimal place. For example, if the EUR/USD currency pair is trading at 1.1250, then the last digit “0” represents a pip.
Pips are used to calculate the profit or loss in a trade, and they determine the value of a currency pair. When a currency pair increases or decreases in value, the change is measured in pips. For example, if the EUR/USD currency pair increases by 10 pips from 1.1250 to 1.1260, it means that the euro has strengthened against the US dollar.
How are pips calculated?
Calculating pips is relatively simple, and traders can do it manually or use an online pip calculator. The formula for calculating pips depends on the currency pair’s quote currency and the trade’s size.
For example, let’s say a trader buys 1 lot of the EUR/USD currency pair at 1.1250 and closes the trade at 1.1300. To calculate the profit or loss, we need to calculate the number of pips gained or lost.
The formula for calculating pips in this scenario is as follows:
Number of pips gained or lost = (Closing price – Opening price) / Pip value
The pip value for the EUR/USD currency pair is $10 per pip for a standard lot (100,000 units), $1 per pip for a mini lot (10,000 units), and $0.10 per pip for a micro lot (1,000 units).
Using the above formula, we can calculate the number of pips gained or lost:
Number of pips gained or lost = (1.1300 – 1.1250) / $10 = 5 pips
Therefore, the trader has gained 5 pips, and the profit can be calculated by multiplying the number of pips gained by the pip value:
Profit = 5 pips x $10 per pip = $50
Similarly, if the trader had sold 1 lot of the EUR/USD currency pair at 1.1250 and closed the trade at 1.1200, the number of pips gained or lost would be:
Number of pips gained or lost = (1.1200 – 1.1250) / $10 = -5 pips
In this scenario, the trader has lost 5 pips, and the loss can be calculated by multiplying the number of pips lost by the pip value:
Loss = -5 pips x $10 per pip = -$50
Conclusion
Pips are an essential concept in forex trading, and understanding how they are calculated is crucial for traders. Pips help traders to determine the profit or loss in a trade and the value of a currency pair. The formula for calculating pips depends on the currency pair’s quote currency and the trade’s size, and traders can use an online pip calculator or do it manually. By understanding how pips are calculated, traders can make informed decisions and manage their risk effectively.
