What is a forex pip? This is among the questions that you should be able to answer before you start life as a forex trader. If you can’t answer the question of what is forex pip, don’t rush into forex trading first.
I always say that it is good to invest in education as you start your forex trading endeavors. The moment you decide to jump into the forex market without the necessary knowledge, you are calling for trouble.
One thing that I never understand is how someone is willing to undertake a higher education degree and endure four years at the university without any complaints so that you can get a good job after attaining the degree.
Then the very some person wants to start a career in forex trading so that they can make more money than they are earning in their current job.
However, you are not willing to invest even a few months in studying all the necessary details, and gain the needed experience in the forex market. You just want to come in and start making a “crapload of money” immediately.
I am sorry to tell you that forex trading is a skill that you ought to invest your time in order to become a profitable forex trader.
If anyone has told you anything else, you have been misled big time.
This is why most beginners in forex trading end up saying that forex trading is a scam since they invest their money blindly and lose it all.
Don’t strive to be among such traders.
Now that I am done with ranting, I can go ahead and outline what is a forex pip.
What is a Forex Pip?
To begin with, a forex pip is a unit of measurement for currency movement and is the fourth decimal place in the majority of the currency pairs’ price.
For instance, if the USDCHF moves from 1.2035 to 1.2036, that’s a single pip movement.
Most brokers offer fractional pip pricing; therefore, you’ll also see a fifth decimal place like in 1.20365, where the 5 is equivalent to five-tenths of a pip, or five pipettes.
Now that you know what is a forex pip, I can move to how a pip works.
Now that you know what is a pip in forex, let me elaborate how pips work.
How Pips Work
You are aware that physical goods, including groceries and clothing, can be bought with money in simple decimal notation.
Dollars, for instance, are divided into cents, and many currencies can be shared into increments of one-hundredths or the equivalent of 0.01.
However, in currency trading, the item bought is another currency. Additionally, currencies are mainly traded worldwide in large volumes.
As per data from the Bank for International Settlements, over US$5 trillion in currencies can be traded in the world market in a day.
In this environment, even small price movements can result in a large volume of money changing hands if a transaction is of a large size.
Due to this, it is better to trade currencies in smaller increments of one ten-thousandth.
In the exchange rate, movement is measured by pips.
Given that majority of currency pairs are mostly quoted to a maximum of four decimal places, as a result, the smallest change for these pairs is 1 pip.
A pip’s value can be calculated by dividing 1/10,000, which is 0.0001 by the prevailing exchange rate.
For instance, a trader that wishes to purchase the EURUSD pair would be buying Euros while at the same time selling US Dollars.
Equally, a trader who wishes to sell the Euros would sell the EURUSD pair and buy the US dollars at the same time.
Japanese Yen (JPY) pairs are usually cited with two decimal places hence marking a remarkable exception to the four decimal rule.
For currency pairs such as the USDJPY and GBJPY, the value of a pip is 1/100 divided by the prevailing exchange rate.
For instance, if the GBPJPY pair is quoted as 132.62, one pip is 1/100 ÷ 132.62 = 0.0000754.
Traders normally use the term “pips” to signify the spread that exists between the bid and ask prices of the currency pair at hand and to indicate the gain or loss that can be attained from a trade.
Profit or loss from a forex pip movement relies on both the currency pair you are trading and the currency that you used to fund your trading account.
Pip value is important because it affects the inherent risk.
If you are not aware of what the pip value is, you can’t quite calculate the perfect position size for a trade, and you could end up risking a lot or too little on a trade.
Remember, while trading, you should only be risking a specific percentage of your account for any trade that you enter.
That should be a percentage that you are willing to risk, and you are comfortable with losing in case the market moves against your direction. This is something that helps to eliminate emotions as your trade.
Risking only a percentage of your account will ensure you do not blow up your trading account even when you encounter a rough patch of several losing trades.
Calculating Forex Price Moves
With a clear understanding of what is a forex pip and how it works, let’s see how much money you can gain or lose for every market movement. The size of your trade position will determine this, with the same price movement in pips, larger positions will have more monetary repercussions on your account balance.
This can be calculated in a manner like (positions size x 0.0001 = Monetary value of a pip)
I can demonstrate this with an example using the GBPUSD pair, as we have above.
If you open a position size of 10,000 units, you will calculate the pip value as follows
10,000 (units) x 0.0001 (one pip) = $1 per pip.
Once you open a position of BUY and the market works as per your prediction, each pip movement will earn you $1, and the visa versa is true if you SELL.
In case the market goes contrary to how you predict on either a buy or sell trade, $1.00 will be lost for each pip movement that the trade makes.
Reducing or increasing the amount of units will have the same impact on the pip value.
Account Denomination Pip Value
In any case, it is a global market, and not all traders have their accounts denominated in the same currency. The meaning of this is that the pip value must be translated to any currency that our account may be traded in.
What you are supposed to do is simply multiply or divide the “found pip value” by the exchange rate of your trading account currency and the currency being considered.
When the “found pip value” currency is the same currency like the base currency in the exchange rate quote, it would go something like the example below….
If you have a EURJPY currency pair, you can change the found pip value of .721 EUR to the pip value in USD by using EURUSD at 1.1290 as your exchange rate ratio.
When the currency you are converting to is the counter currency of the exchange rate, you are only expected to divide the “found pip value” with the corresponding exchange rate ratio.
Going with the example above,
.721 EUR per pip / (1 EUR/1.1290 USD) = 0.8140 USD per pip move
Therefore, for each .01 pip move in EUR/JPY, the value of a 10,000 unit tends to change by about 0.81 USD.
What happens when the currency you are changing to is the base currency of the conversion exchange rate ratio?
Here, you multiply the conversion exchange rate ratio with the “found pip value.”
Going with a currency pair like USDCHF, and you purpose to find the pip value of .87 USD in Canadian dollars.
You can be using maybe .7420 as the conversion exchange rate ratio:
0.87 USD per pip X (1 CAD/.7420 USD) = 1.1725 CAD per pip move
In this case, for each .0001 pip move in USDCHF, your 10,000 unit position converts in value by around 1.17 CAD.
After knowing what is forex pip, I know there are a lot of things going in your mind right now regarding the calculations I have tried to demonstrate above.
Do I really need to be working out all this? This might be among the questions in your head, I know.
The answer is NO!
You do not need to calculate the pip values manually since the forex broker that you are using will automatically handle this for you.
However, it is good when you know how they work it out.
In case your broker fails to do this, worry not as you can use a pip value calculator. They are many out there.
I hope by now, you have learned what is a forex pip and the other inherent aspects involved with the forex pip.