Forex trading can be a complex world to navigate, especially for beginners. One of the most commonly used terms in the forex market is “pip”. Pips are a crucial part of forex trading as they determine the profits and losses of a trade. In this article, we’ll explain what pips are, how they work and how to calculate them.
What is a pip?
Pip stands for “percentage in point”, and it is the smallest unit of measurement in the forex market. It is used to measure the change in price of a currency pair. Forex traders use pips to calculate the profit or loss of a trade, as well as to determine the spread, which is the difference between the bid and ask price.
For example, if the EUR/USD currency pair is trading at 1.2000 and it moves up to 1.2001, that is a one pip increase. If it moves down to 1.1999, that is a one pip decrease. Most currency pairs are quoted with four decimal places, so a pip is usually equal to 0.0001.
How does pip value work?
The value of a pip depends on the size of the trade and the currency pair being traded. In general, the value of a pip is calculated by multiplying the pip value by the position size. The pip value differs from one currency pair to another due to the fluctuations in exchange rates.
For example, let’s say you are trading the EUR/USD currency pair and your account is denominated in USD. The pip value for one standard lot (100,000 units) of EUR/USD is $10. This means that if the currency pair moves one pip in your favor, you will make $10 profit. If the currency pair moves one pip against you, you will lose $10.
Calculating pip value
To calculate the pip value of a trade, you need to know the following:
• The currency pair being traded
• The exchange rate of the currency pair
• The size of the trade (in units)
Here’s the formula to calculate the pip value:
Pip value = (size of trade in units x one pip) / exchange rate
Let’s say you are trading the GBP/USD currency pair with a standard lot size of 100,000 units, and the exchange rate is 1.3000. The pip value would be:
Pip value = (100,000 x 0.0001) / 1.3000 = $7.69
This means that if the currency pair moves one pip in your favor, you will make $7.69 profit. If it moves one pip against you, you will lose $7.69.
What is a pipette?
Sometimes, you may come across a currency pair that has five decimal places instead of four. In this case, the last digit is called a “pipette”. A pipette is equal to one-tenth of a pip, or 0.00001. Some brokers display pipettes to provide more accurate pricing, especially for currency pairs that are highly volatile.
Conclusion
Pips are a fundamental concept in forex trading. Understanding what a pip is and how to calculate it is essential for traders to manage their risk effectively and make informed trading decisions. By knowing the pip value of a trade, traders can determine their potential profits and losses, and adjust their position sizes accordingly.
