Forex trading is a lucrative business that attracts investors from all over the world. The market is highly volatile, and traders need to have a thorough understanding of the various terminologies used in trading. One such term that every forex trader must know is PIP. In this article, we will discuss what PIP is, how to calculate it, and why it matters in Forex trading.
What is PIP?
PIP stands for Percentage In Point, and it is the smallest unit of measurement in Forex trading. PIPs are used to measure the change in the value of a currency pair, and they represent the fourth decimal place of a currency pair’s price. For example, if the EUR/USD currency pair is trading at 1.1200, and it rises to 1.1205, the change in value is 5 PIPs.
How to Calculate PIP?
Calculating PIP is relatively easy, and it only requires basic math skills. To calculate PIP, you need to know the current exchange rate of the currency pair you are trading. Let’s take the EUR/USD currency pair as an example. If the current exchange rate is 1.1200, and it rises to 1.1205, the change in value is five PIPs.
The formula for calculating PIP is:
PIP = (0.0001 / Exchange Rate) x Trade Size
For example, if you are trading one standard lot (100,000 units) of the EUR/USD currency pair, and the exchange rate is 1.1200, the PIP value would be:
PIP = (0.0001 / 1.1200) x 100,000
PIP = 8.93
This means that every time the EUR/USD currency pair moves by one PIP, you will earn or lose $8.93, depending on your position.
Why PIP Matters in Forex Trading?
PIP is an essential concept in Forex trading, and it matters for several reasons. Firstly, it allows traders to calculate their potential profits or losses accurately. By knowing the PIP value of a currency pair, traders can determine the amount of money they stand to gain or lose based on their position.
Secondly, PIP can also determine the size of a trader’s position. For example, if a trader has a $10,000 account and wants to risk 1% of their account on a trade, they can use the PIP value to determine the size of their position. If the PIP value of the currency pair is $10, and the trader wants to risk $100, they can trade one standard lot of the currency pair.
Lastly, PIP also affects the cost of trading. Most Forex brokers charge a spread, which is the difference between the buy and sell price of a currency pair. For example, if the EUR/USD currency pair has a bid price of 1.1200 and an ask price of 1.1205, the spread is five PIPs. This means that a trader would need to earn or lose at least five PIPs to break even on the trade.
In conclusion, PIP is an essential concept in Forex trading, and every trader must have a thorough understanding of how to calculate it and why it matters. PIP allows traders to calculate their potential profits or losses accurately, determine the size of their position, and understand the cost of trading. By knowing the PIP value of a currency pair, traders can make informed decisions and increase their chances of success in the Forex market.