Forex trading is an exciting and potentially lucrative activity, but it can also be complicated and confusing for beginners. One of the most important concepts to understand in forex trading is the pip. A pip is the smallest unit of measurement in the forex market, and it is used to calculate the profit or loss of a trade.
In this article, we will explain what pips are, how they are calculated, and how to use them in forex trading.
What is a Pip?
A pip is a unit of measurement used in forex trading to measure the change in the value of a currency pair. It stands for “percentage in point” or “price interest point.” Pips are the fourth decimal place in a currency pair, except for pairs involving the Japanese yen, which are measured to the second decimal place.
For example, if the EUR/USD currency pair moves from 1.1200 to 1.1210, that is a movement of 10 pips. If the USD/JPY currency pair moves from 109.00 to 109.10, that is also a movement of 10 pips.
Calculating pips is relatively simple, but it can be confusing for beginners. To calculate the pip value of a trade, you need to know the following:
– The currency pair you are trading
– The size of your trade
– The current exchange rate
Once you have this information, you can use the following formula to calculate the pip value:
Pip value = (1 pip / exchange rate) x trade size
Let’s break down this formula:
– 1 pip: This is the smallest unit of measurement in the forex market. It is equal to 0.0001 for most currency pairs, except for pairs involving the Japanese yen, which are measured to the second decimal place (0.01).
– Exchange rate: This is the current exchange rate for the currency pair you are trading. For example, if you are trading the EUR/USD pair and the current exchange rate is 1.1200, that means one euro is worth 1.1200 U.S. dollars.
– Trade size: This is the size of your trade, measured in lots. A lot is a standard unit of measurement in forex trading, and it typically represents 100,000 units of the base currency. However, you can also trade in mini lots (10,000 units) or micro lots (1,000 units).
Let’s look at an example to see how this formula works in practice.
Let’s say you are trading the EUR/USD currency pair, and you have a trade size of 1 lot. The current exchange rate is 1.1200. You want to calculate the pip value of this trade.
Using the formula above, we can calculate the pip value as follows:
Pip value = (1 pip / 1.1200) x 100,000
Pip value = 0.0000893 x 100,000
Pip value = 8.93 U.S. dollars
This means that for every pip movement in the EUR/USD pair, your profit or loss will be 8.93 U.S. dollars.
Using Pips in Forex Trading
Now that you understand how to calculate pips, how can you use this information in forex trading?
Pips are important because they help you calculate the profit or loss of a trade. For example, if you buy the EUR/USD pair at 1.1200 and sell it at 1.1220, that is a profit of 20 pips. Using the formula above, you can calculate that your profit on this trade would be:
Profit = (20 pips x 1 lot x 0.0001) x 100,000
Profit = 20 U.S. dollars
On the other hand, if you buy the EUR/USD pair at 1.1200 and sell it at 1.1180, that is a loss of 20 pips. Using the same formula, you can calculate that your loss on this trade would be:
Loss = (20 pips x 1 lot x 0.0001) x 100,000
Loss = 20 U.S. dollars
Pips are also important because they can help you manage your risk in forex trading. By setting a stop loss order, you can limit your potential losses on a trade to a certain number of pips. For example, if you set a stop loss order 20 pips away from your entry point, you will only lose 20 pips if the trade goes against you.
Pips are a fundamental concept in forex trading, and understanding how to calculate them is essential for success. By using the formula above, you can calculate the pip value of a trade and use this information to manage your risk and calculate your potential profits and losses. With practice and experience, you can become more comfortable with using pips in your trading strategy and make more informed trading decisions.