Surely you have heard the word “pips” more than once. But what is a pip? What does it mean? Today, I want to explain what a pip in forex trading is and how to calculate it.
What is a Pip?
A pip stands for “Percentage In Point,” and it is the smallest change in price which a currency pair can change.
A pip is usually the 4th decimal place on most currency pairs. Let’s take the most common currency pair EUR/USD as an example with a value of 1.1958. This means that you currently get 1.1958 dollars for one euro. Let’s say EUR/USD price rises from 1.1958 to 1.1988. The price has changed by 30 pips.
Only with the Japanese YEN pairs (e.g., USD/JPY) a pip is the 2nd decimal place. For example, when quoting USD against YEN, one pip equals one-hundredth of one YEN (JPY 0.01). So if USD/JPY moves from 104.12 to 103.82, the price has dropped by 30 pips.
In recent years, there has been a move to display rates with five decimal places in order to make currency trading attractive for smaller accounts.
Since the forex currency pairs are always quoted in the rear currency, the profit or loss when trading occurs in this currency as well.
For the EUR/USD currency pair, the profit or loss would be in US dollars, and for the USD/CAD currency pair, the profit or loss would be in Canadian dollars.
Thus, one pip is the smallest change in value for any given forex quote, whether it’s quoted to two or four decimal places. Here are more examples:
When the EUR/USD price moves up from 1.3255 to 1.3287, it is a movement of 32 pips.
Likewise, when the EUR/USD price moves down from 1.3255 to 1.3138, it is a movement of 117 pips.
When the USD/CHF price moves up from 0.9148 to 0.9263, it is a movement of 115 pips.
Likewise, when the USD/CHF price moves down from 0.9148 to 0.9126, it is a movement of 22 pips.
When the USD/JPY price moves up from 80.55 to 80.87, it is a movement of 32 pips.
Likewise, when the USD/JPY price moves down from 80.55 to 79.78, it is a movement of 77 pips.
Today, many brokers extend forex quotes beyond the standard four and two decimal places to five and three decimal places, respectively. As an example, a broker could quote USD/CAD as 1.00583. If the USD/CAD price rises to either 1.00584 or falls to 1.00582, the movement is termed 1 pipette.
Similarly, if USD/JPY is quoted as 81.338 and if the currency pair rises to either 81.339 or falls to 81.337, the movement is termed 1 pipette.
How to Calculate the Pip Value?
The pip value calculation in Forex trading is straightforward because the pip value corresponds to the 4th decimal place for common currency pairs and only the 2nd decimal place for Japanese currency pairs.
Let’s see an example.
Suppose the EUR/USD rate is 1.15272:
This means that you currently get 1.15272 dollars for one euro. If the price rises to 1.15282, it is called an increase of 1 pip = 0.0001.
Similarly, if the USD/JPY rate is 113.800 and the price now rises to 113.810, you have an increase of 1 pip = 0.01.
If we want to calculate our risk in forex trade, then we have to multiply the position size by the pip value, and the number of pips risked.
Example 1 – EUR/USD
We buy EUR/USD at 1.2830, and let’s say our stop loss is 1.2790. So our risk is 40 pips.
If we trade a so-called standard lot, i.e. buy 100,000 USD, our risk is 100,000 * 0.0001 * 40 = 400 USD.
In other words, the standard lot has a pip value of USD 10.
Since we usually keep our account in euros, we must convert the pip value into euros.
Currently, that would be 10 USD * 0.7795 = 7.795 euros, where 0.7795 is the exchange rate from 1 USD to one euro.
Example 2 – AUD/CAD
We are buying at 1.1085 with a stop loss at 1.1050. So our risk is 35 pips.
The AUD/CAD currency pair is traded in CAD, with AUD being the so-called base currency and CAD being the so-called quote currency.
We are trading a standard lot of CAD 100,000 and want to know how high our risk is.
The calculation would be: 100,000 * 0.0001 * 35 = 350 CAD.
With the standard lot, one pip brings about a change in the value of 10 CAD.
Now we need the conversion factor from CAD to EUR, which is currently 0.6291, with which we would take the risk of 350 CAD * 0.6291 = 220.18 EUR.
PS Below is an interesting video on “Pips and Points”.
I hope I have been able to clarify what is a pip and how to calculate the pip value in forex trading with the help of this post.
Read also the article “What is Forex Spread?”…