The forex market is an exciting and dynamic marketplace that offers numerous opportunities for traders to make profits. However, before you start trading currencies, it is essential to understand the basic terminologies used in forex trading. One of the most important terms used in forex trading is pips. In this article, we will define what pips are, how they are calculated, and their significance in forex trading.
What is a Pip?
In forex trading, a pip is a unit of measurement used to express the change in the value of a currency pair. A pip stands for “Percentage in Point” or “Price Interest Point.” It is the smallest unit of movement in the price of a currency pair. For most currency pairs, a pip is equivalent to 0.0001, except for the Japanese Yen, where a pip is equivalent to 0.01.
For instance, if the EUR/USD currency pair moves from 1.1200 to 1.1201, it means that it has increased by one pip. Conversely, if the same currency pair moves from 1.1200 to 1.1199, it means that it has decreased by one pip.
How are Pips Calculated?
The calculation of pips depends on the currency pair being traded. For currency pairs that involve the US dollar, the pip value is always fixed at $10 for standard lots, $1 for mini lots, and $0.10 for micro lots. This means that if a trader buys one standard lot of the EUR/USD currency pair at 1.1200 and sells it at 1.1201, they will earn $10 for every pip increase.
On the other hand, for currency pairs that do not involve the US dollar, such as the EUR/GBP, the pip value is calculated differently. In this case, the pip value is determined by multiplying the exchange rate with the position size and the pip value of the currency pair. For instance, if a trader buys one standard lot of the EUR/GBP at 0.8500 and sells it at 0.8501, the pip value will be calculated as follows:
Pip value = (0.0001/0.8501) x 100,000 x 1 = 11.76 GBP
This means that the trader will earn 11.76 GBP for every pip increase.
The Significance of Pips in Forex Trading
Pips play a crucial role in forex trading as they determine the profitability or loss of a trade. The value of pips varies depending on the currency pair being traded, the position size, and the lot size. In forex trading, the objective is to buy a currency pair at a lower price and sell it at a higher price to make a profit.
For instance, if a trader buys one standard lot of the EUR/USD currency pair at 1.1200 and sells it at 1.1205, they will earn $50 for every pip increase. On the other hand, if the same trader buys one standard lot of the EUR/USD currency pair at 1.1200 and sells it at 1.1195, they will lose $50 for every pip decrease.
Therefore, it is important for traders to understand the value of pips to determine their potential earnings or losses in a trade. Traders should also use stop-loss orders to limit their losses in case the market moves against them.
Conclusion
In conclusion, a pip is a unit of measurement used in forex trading to express the change in the value of a currency pair. It is the smallest unit of movement in the price of a currency pair, and its value varies depending on the currency pair being traded, the position size, and the lot size. Understanding the value of pips is crucial for traders as it determines the profitability or loss of a trade. Traders should use stop-loss orders to limit their losses in case the market moves against them.
