The foreign exchange market is a dynamic and complex market, that requires traders to have a deep understanding of different trading terminologies and strategies. One of the most important concepts in forex trading is the pip, which stands for “percentage in point”. Pips are used to measure the price movement of currency pairs in forex trading. Understanding how to calculate pips is crucial for any forex trader, as they are used to determine profit and loss, as well as to set stop-loss and take-profit orders.
What is a pip?
A pip is the smallest unit of price change for a currency pair in forex trading. It is usually measured in the fourth decimal point, but in some cases, it can be measured in the fifth decimal point, depending on the currency pair. For example, in the EUR/USD currency pair, if the price moves from 1.1500 to 1.1501, it is considered a one pip movement. In the USD/JPY currency pair, if the price moves from 112.00 to 112.01, it is also considered a one pip movement.
How to calculate pips?
Calculating pips in forex trading is relatively easy. The formula for calculating pips varies depending on the currency pair and the quote currency. In general, the formula for calculating pips is as follows:
Pip Value = (Position Size x Exchange Rate) / Pip Value Factor
The pip value factor depends on the quote currency of the currency pair. For currency pairs that have the USD as the quote currency, the pip value factor is usually 1. For other currency pairs, the pip value factor is calculated based on the exchange rate of the quote currency against the USD.
Let’s take an example to understand how to calculate pips in forex trading. Suppose you buy 1 lot (100,000 units) of the EUR/USD currency pair at an exchange rate of 1.1600. Your position size is 1 lot, and the exchange rate is 1.1600. The pip value factor for the EUR/USD currency pair is 1, as the USD is the quote currency.
Pip Value = (Position Size x Exchange Rate) / Pip Value Factor
Pip Value = (100,000 x 1.1600) / 1
Pip Value = $1,160
Therefore, in this example, the pip value for the EUR/USD currency pair is $1,160.
Calculating profit and loss using pips
Pips are used to calculate profit and loss in forex trading. The profit or loss on a trade is calculated by multiplying the number of pips gained or lost by the pip value. If you buy a currency pair and the price moves in your favor, you make a profit. If the price moves against you, you make a loss.
Let’s take an example to understand how to calculate profit and loss using pips. Suppose you buy 1 lot of the EUR/USD currency pair at an exchange rate of 1.1600, and you close the trade at an exchange rate of 1.1650. Your profit is calculated as follows:
Number of pips gained = (Closing Price – Opening Price) / Pip Size
Number of pips gained = (1.1650 – 1.1600) / 0.0001
Number of pips gained = 50
Profit = Number of pips gained x Pip Value
Profit = 50 x $1,160
Profit = $58,000
Therefore, in this example, your profit is $58,000.
Setting stop-loss and take-profit orders using pips
Pips are also used to set stop-loss and take-profit orders in forex trading. A stop-loss order is an order placed to limit the potential loss on a trade, while a take-profit order is an order placed to lock in profits on a trade. Both stop-loss and take-profit orders are set in pips.
Let’s take an example to understand how to set stop-loss and take-profit orders using pips. Suppose you buy 1 lot of the EUR/USD currency pair at an exchange rate of 1.1600, and you want to set a stop-loss order at 1.1550 and a take-profit order at 1.1700.
Stop-Loss Order = Entry Price – Stop-Loss in Pips x Pip Value
Stop-Loss Order = 1.1600 – 50 x $1,160
Stop-Loss Order = 1.1050
Take-Profit Order = Entry Price + Take-Profit in Pips x Pip Value
Take-Profit Order = 1.1600 + 100 x $1,160
Take-Profit Order = 1.2760
Therefore, in this example, your stop-loss order is set at 1.1550, and your take-profit order is set at 1.1700.
Conclusion
In conclusion, pips are an essential concept in forex trading, as they are used to measure the price movement of currency pairs, calculate profit and loss, and set stop-loss and take-profit orders. Understanding how to calculate pips is crucial for any forex trader, as it can help them make informed trading decisions, manage risk, and maximize their profits.
