Forex trading is an exciting and dynamic market that attracts millions of traders from all over the world. However, it is also a complex market with its own set of rules and terminologies. One of the most important terminologies in forex trading is “pips”. In this article, we will explain what pips are in the forex market and how they are calculated.
What are Pips?
A pip is the smallest unit of measurement in forex trading. It stands for “Percentage in Point” or “Price Interest Point”. It is the fourth decimal place in a currency pair or the second decimal place in a JPY-based currency pair. For example, if the EUR/USD is trading at 1.1205, then the fifth decimal place (0.0001) is the pip. Similarly, if the USD/JPY is trading at 109.60, then the third decimal place (0.01) is the pip.
Pips are used to calculate the profit or loss in a trade. If a trader buys a currency pair at a certain price and sells it at a higher price, then he makes a profit. The amount of profit he makes depends on the number of pips the currency pair has moved. Similarly, if a trader sells a currency pair at a certain price and buys it at a lower price, then he makes a profit. Again, the amount of profit he makes depends on the number of pips the currency pair has moved.
How are Pips Calculated?
Pips are always calculated in the currency of the quote currency. For example, if you are trading the EUR/USD, then the pip value will be in USD. If you are trading the USD/JPY, then the pip value will be in JPY.
To calculate the pip value, you need to know the exchange rate of the currency pair and the lot size of your trade. A lot is a standard unit of measurement in forex trading. It represents a certain amount of currency that you are buying or selling. The standard lot size is 100,000 units of the base currency. However, there are also mini lots (10,000 units) and micro lots (1,000 units).
The formula to calculate the pip value is as follows:
Pip Value = (1 pip / Exchange Rate) x Lot Size
For example, let’s say you are trading the EUR/USD and the exchange rate is 1.1205. You have bought one standard lot (100,000 units) of the currency pair at 1.1205. If the price of the currency pair moves up to 1.1215, then it has moved 10 pips. To calculate the profit or loss, you need to know the pip value.
The pip value in this case is:
(0.0001 / 1.1205) x 100,000 = $8.93
So, if the price of the currency pair moves up 10 pips, then you have made a profit of $89.30 (10 x $8.93).
Similarly, if the price of the currency pair moves down 10 pips, then you have made a loss of $89.30.
Why are Pips Important?
Pips are important in forex trading because they determine the profit or loss in a trade. They also help traders to manage their risk and calculate their position size. By knowing the pip value, traders can calculate the amount of money they need to risk in a trade and the number of units they can buy or sell.
Pips also play a role in the spread, which is the difference between the bid and ask price of a currency pair. The spread is usually measured in pips. The lower the spread, the better it is for traders because they can buy or sell at a lower cost.
Conclusion
Pips are an essential part of forex trading. They help traders to calculate their profit or loss, manage their risk, and calculate their position size. By understanding pips, traders can make informed decisions and improve their trading performance.
