What Is A Pip In Forex?

By Steven Hatzakis Sunday, January 7, 2018
Pip in Forex is one of the most fundamental terms that every trader have to understand fully. And this post gives you the best explanation of it! 

Introduction

As a Forex trader, you have to get familiar with a lot of numbers. The more information and data you have, the easier it is for you to keep track of the currencies. So, it’s essential for you to have basic knowledge and understanding of the terminologies used in the market. One noteworthy term is Pip. In this post, we’d like to offer you the definition and explanation of how a Pip in Forex work.

Definition

The term “Pip” is short for "Percentage In Point" and also known as the price interest point. It designates the smallest change in price of a currency pair. A Pip refers to the fourth decimal point of a price, which is 1/100th of 1%.

The Value of Pips

When you’re trading, the Pip value is based on your lot size. The lot size decides how much a Pip move can affect your account. On a small trade, a 100 Pip move will not make much difference as a 100 Pip move on a larger trade size.
For example, for micro lots, 1 Pip is equivalent to 10 cents, so it is highly recommended for beginners. For mini lots, a Pip would worth about $1, and the market can move 100 Pips a day or even in an hour, meaning that you can lose up to $100 at once when the trade goes against you.

Lastly, standard lots are not frequently traded between Forex traders because 1 Pip is worth $10 and they require an amount of at least $25,000 to trade. Consequently, traders should make affordable trades in order to survive long term.

Therefore, the Pip value in the Forex market can be calculated by this formula:

Pip Value = (Pip in decimal places * trade size) / exchange rate
Example: Trading a lot of EUR/USD with EUR-denominated 
1 Pip in decimals = 0.0001, trade size = 10000, exchange rate = 1.20382
= (0.0001 x 10000)/1.20382 = 0.8307
So, each Pip is worth roughly $1

You’re making a profit when your trade is positive in Pips. Otherwise, your trade is underwater. For example, it is a good deal when you’re trading with EUR/USD, and it moves from 1.20382 to 1.20392 (10 Pips)
     
The value of a Pip also varies based on what currency pairs you trade in which a currency is either the base currency or counter currency.  When you open a USD-denominated account, the Pip value on a mini lot will always be $1 for one 10,000 lot of the pair if the US dollar is the counter currency. Therefore, a 100-Pip rise in CAD/USD is similar to a 100-Pip rise in GBP/USD. Changes in Pip value can only be seen when there are major changes in the price of the U.S. dollar or when the U.S. dollar is the base currency or not included in the pair, such as EUR/JPY.

From 2008 to 2011, the value of USD/JPY decreased from approximately 120 down to just 77.5. Each movement became more valuable per Pip in US dollars because of the significant growth of the JPY. However, such cases are very rare, but it demonstrated that Pip values aren’t always stable and not all Pips are equal.

Fractional Pips/ Pipettes

Some Forex brokers also allow trades to proceed in fractional Pips which allow tighter control on profits/losses and make spreads more flexible. Those fractional Pips are also known as Pipettes to be more precise. If the currency pair you’re trading, EUR/USD for example, went from 1.20382 to 1.20383, that is one Pipette.
With that said, one Pipette can be seen to five decimal places on a currency pair. Traders usually deal with Pips, but looking at Pippettes can be more helpful when deciding on whether you want to continue a trade or not.

Examples

You would have to convert $1 into Euros by dividing it with the EUR/USD exchange rate when your trading account is EUR-based. Since a US dollar is worth less than a Euro, you should get a number that is less than 1. For example, with the current exchange rate of 1.2038 and you take 1 divided by 1.2038, you would get 0.8307, meaning that you would earn or lose 0.8307 Euros on a mini lot.

For the Japanese Yen (JPY), a Pip is seen to four decimal places. With an example of trading EUR/JPY on a mini lot, each Pip is worth 0.01 because the Japanese Yen is involved. Because it is the counter currency, we need to convert 100 Yen (10,000 x 0.01) into Euros. Using the same formula with the current exchange rate of 136.08 for the EUR/JPY pair, it would be 0.73 Euros per Pip.

Pip Relevant to Spread and Hedge

Pip is used to measure spread. As mentioned before, spread is the difference between bid (how much is offered for a pair) and ask (how much sellers ask for a pair) prices when quoting any currency pair.

While hedging, traders should take Pip values into account because hedging can be a risky position although it is meant to protect traders from huge losses. When breaking events occur like the Swiss National Bank unpegging the Francs (CHF) in 2015, or the huge volatility seen in the consequences of the EU Referendum resulting in Brexit (Britain exiting EU), the spread can rise to more than 100 Pips regardless of the liquid pairs. Furthermore, a hedged trader’s loss would be much worse when trading a pair that is not liquid in the Forex market.

Conclusion

Although Pip in Forex is one of the most basic terms you need to grasp properly, it still has its complexity when you’re just starting out in trading. However, that is not all there is to trading in the Forex market. In order to become a successful trader, you must first master other specialized terms that you will inevitably come across in the Forex world.