What is a Pip in Forex Trading?

Percentage of points or pips refers to the movement of tiny increments of currency price. Under most circumstances, a pip is 1/100th of 1%.

For example, EUR/USD changed from 1.05172 to 1.05182, the pip’s rise in value is 0.0001 USD, also referred to as basis point. Also, most currency pairs have a maximum of four decimal places and the lowest pip value of one.

Understanding Pips

Pip is the most basic calculation tool to measure a movement in the exchange rate of a given currency pair. It is about 1/100th of a percentage point or 1/10th of a percent, which is the same as ten basis points, 100 basis points, or 0.1%. Forex traders primarily use pips to measure small price movements in currency rates.

A “pip” is a term used in currency trading to describe the fractional movement of a currency relative to another, i.e., a 1% change in the EUR/USD rate would be considered 100 pips.

Every time one buys or sells one unit of a currency pair, it could result in up to four pips (or fractions).

How is Pip Calculated?

Pip is one of the primary concepts of foreign exchange or forex. Forex traders use EUR/USD, EUR/CAD, or other pairs to bid and buy up to the fourth decimal currency exchange, and the fifth decimal is called a pipette. A pip is a minor exchange rate movement, and the value is calculated after dividing 0.0001 or 1/10,000 by the exchange rate.

An exception to the pip rule is the Japanese Yen or JPY, which quotes up to two decimals. Therefore, the pip value of USD/JPY or EUR/JPY 1/100, divided by the exchange rate.

For example, if the EUR/JPY rate is 133.62, the pip value is 1/100 divided by 133.62, i.e., 0.00007483909.

Similarly, 1/10th of the pip is a fractional pip and remains at the end of the price as a superscript. So, for example, if the EUR/USD value changes from 1.10260 to 1.10360, the fractional pip increase is ten. Likewise, the USD/JPY value changes from 106.500 to 105.950; the decrease is ten pips.

Profit and Loss in Pips

Forex trading involves two pairs, namely base and counter currencies. , For example, , EUR/USD would have USD as the quote and EUR as the base currency. The change in pip multiplied by the base currency is the pip value of profit.

Let us understand the effect of pip movement on profits and loss of traders with the example:

Example 1: Long on EUR/USD

Suppose EUR/USD currency pair is currently trading at 1.2150/1.2152. Here, 1.2150 is the bid price (sell) and 1.2152 is the ask price (buy). The spread here in this example is 2 pips which is the difference between the bid and ask price in pips.

Suppose you placed a buy order with 100,000 units (standard lot) of the EUR/USD pair with a leverage of 1:20. To place this order you will need a certain amount in your account equity.

100,000 X 1.2152 X 1/20 = $6076

Once you place this buy order, each upward movement of 1 pip will generate a profit of $10. It must be noted that the profits will only be visible after 3 pip movement as 2 pip is the spread. After covering the spread each increment of 1 pip will generate a $10 profit.

Every time you trade a standard lot i.e. 100,000 units, a movement of 1 pip will generate a profit of $10. 100 pip increment will generate a $1000 profit in this case.

Similarly, a drop of 1 pip will generate losses of $10 per 1 pip.

Example 2: Long on USD/JPY

To comprehend this example of long position on USD/JPY with 1 standard lot, it must be noted that JPY is the quote currency here, so the profits will be in JPY. We will need to convert JPY profits to USD to get a better estimation of the profit.

Suppose the USD/JPY currency pair is trading at 105.00/105.02, to open a position with the standard lot (100,000 units), traders will need the following amount in their account equity with a leverage of 1:20.

100,000 X 105.02 X 1/20 = JPY 525,100

JPY 525,100 is nearly equal to $5000 at the conversion rate of 105. Hence, a trader needs a minimum of $5000 in the account equity to open this position. For a 1 pip increment, the profit will be 100,000 X 0.01 = 1000 JPY. For a 100 pip increment, the profit will be 100,000 JPY which is nearly equal to $952.

It must be noted that 1 pip movement in USD/JPY is nearly $10 but not exactly $10 as it is calculated in JPY. Hence, it is fair to say that 1 pip movement in a standard lot of USD/JPY is equal to 1000 JPY.

Calculate Forex Position Size using Pips

Pips can also calculate the forex position size, and if the combined value is significant, the trader could lose the capital. Therefore, it is necessary to trade at a realistic position and involves three steps to calculate forex position size.

Primarily, a trader must decide the capital risk value percentage per trade. For example, if your trading balance is $5,000, the one percent risk value would be $50. The second step includes fixing a pips stop-loss.

For example, the pips stop loss of a EUR/USD at 1.3660 could be 1.3600, and stop-loss would be 60.

The last step includes the trading size, i.e., standard, mini, or micro with 100,000, 10,000, and 1,000 units. The pip value also changes from $10 to $0.10 for each movement. A trader that risks one percent of $5,000 per trader for micro, i.e., $0.10 pip per movement, would have a forex position size often, dividing $50 by 50 pips multiplied by $0.10. Hence, the trader would have ten micro-lots positions.

Historical Examples

The trader’s base currency value affects different currency values. USD is a currency commonly paired with others.

A pair with USD as the exchange currency will have a standard, mini, and micro lot pip values of $10, $1, and $0.10. The two primary reasons for changing pip value include the non-involvement of USD as a currency exchange rate or USD as the base currency.

Another reason could include the movement of USD in either direction by ten percent.

For example, in November 1923, the exchange rate significantly diminished from 4.2 marks/dollar to 4.2 trillion marks/dollar in Germany’s Weimar Republic. Similarly, in 2001, the Turkish Lira made a significant change by removing six zeros from the exchange rate and reached 1.6 million/dollar. January 2021 onwards, Lira’s average exchange rate stands at 7.3/dollar.

The economic conditions of the global market have a significant impact on currency movements and pips.

Imagine a situation where the prices of products are moving beyond imagination or when the costs become too low. The former is called hyperinflation, and the second is a recession. Both these factors tend to make price movements ineffective in forex trading.

Hence, such factors can make trading unmanageable and pip’s invalid.

Hyperinflation has occurred in Argentina, Hungary, Germany, Russia, and China and is the state of an excessive price increase. Meanwhile, devaluation is the deliberated decrease in a country’s money value in China and Brazil. By and large, pips have significance, and their movement can create profits or losses for a trader.

Key Takeaways

• In forex trading, a pip or Percentage in Point is the smallest possible change in the prices of forex pairs.
• A pip is 1/100th of 1% or a unit change at the fourth decimal place i.e. 1 pip movement is equal to 0.0001 movements in forex.
• Japanese Yen is an exception in which 1 pip is equal to 0.01 rather than 0.0001.
• In a trade of a standard lot, 1 pip price movement will result in the $10 movement in the opened position.
• A pipette is equivalent to 1/10 or 0.1 of a pip. The movement of 1 pipette is 0.00001 movement in prices of forex pairs.
• It is important to understand pips to calculate the size of the opened position and predict the possible profits and losses.