Pips The Currency of Currency Trading

Up to this point, pips have been lightly touched upon but not properly defined. An extremely important concept in foreign exchange trading, a pip is simply the smallest unit of price movement in the exchange rate of a currency pair. Pip can stand for "percentage in point" or "price interest point.' ' But regardless of the exact acronym definition, its practical meaning is clear. Traders trade foreign exchange in order to earn pips. Earned pips are the reward for a good trade, while lost pips are the punishment for a bad trade.

Loosely akin to the "tick" found in other financial markets, a pip most often refers to the smallest change in the fourth decimal place of most major currencies. This would be the equivalent of 1/100th of one percent, or one basis point. The notable exception to this would be currency pairs denominated in Japanese yen, or JPY, in which a pip would constitute the smallest change in the second decimal place.

So, for the vast majority of currency pairs like EUR/USD or GBP/CHF or AUD/NZD, the exchange rate format would look like x.xxxx, where a change of 0.0001 would constitute a pip movement. On the other hand, for the handful of currency pairs featuring the yen, like USD/JPY or GBP/JPY, the exchange rate format would look like xxx.xx, where a change of 000.01 would constitute a pip movement.

Calculating the exact value of each pip for the currency pair and lot size traded is the job of the broker 's trading platform, which should include some kind of pip calculator created expressly for this purpose. In its absence, however, here is a simple calculation:

Value Per Pip = [Lot Size] X [Number of Lots] X [Pip Size]

The result of this equation will be denominated in the quote currency (the second currency in the pair). No currency conversion is needed for U.S. dollar-denominated trading accounts if the quote currency is already USD. To obtain the dollar value per pip if the quote currency is anything other than USD, however, the result must be converted to dollars using the current exchange rate between the quote currency and the U.S. dollar. Here are a few examples:

Example 1: Pip value for 1 standard lot of USD/JPY = 100,000 [Lot Size] X 1 [Number of Lots] X 000.01 [Pip Size] = ¥1000 (quote currency in Japanese yen)

Dollar pip value = ¥1000 - 101.00 [current USD/JPY exchange rate] = $9.90/pip

Example 2: Pip value for 1 standard lot of EUR/GBP = 100,000 [Lot Size] X 1 [Number of Lots] X 0.0001 [Pip Size] = £10 (quote currency in British pounds)

Dollar pip value = £10 X 1.9750 [current GBP/USD exchange rate] = $ 19.75/pip

Example 3: Dollar pip value for 1 standard lot of EUR/USD = 100,000 [Lot Size] X 1 [Number of Lots] X 0.0001 [Pip Size] = $10/pip (quote currency already in U.S. dollars)

This may all seem very confusing at first to the beginning trader, but again, most forex trading platforms come well-equipped with a pip calculator that provides all pip values. If this calculator is not offered, it helps to keep in mind that all currency pairs ending in USD (as the quote currency) will be $10/pip for a standard lot,

$1/pip for a mini lot, and $0.10/pip for a micro lot. This includes heavily traded pairs like EUR/USD, GBP/USD, and AUD/USD.

For other key pairs like USD/JPY, USD/CHF, and USD/CAD, their exchange rates as of this writing conveniently place their pip values in the same approximate vicinity as the pairs ending in USD. For a standard lot, these pairs are currently at $9.87/pip, $9.99/pip, and $9.80/pip, respectively.

Finally, it should be kept in mind that while the lot size, amount of lots traded and specific currency pair traded will certainly affect pip value, the leverage chosen by the trader, whether it is 50:1, 400:1 or somewhere in between, has absolutely no bearing whatsoever on pip value.

Forex Trading Manual

Forex Trading Manual

In  any  business  or  moneymaking  venture,  preparation  and foreknowledge are the keys to success.   Without this sort of insight,  the  attempt  to  make  a  profitable  financial  decision can only end in disaster and failure, regardless of your level of motivation  and  determination  or  the  amount  of  money you plan to invest.

Get My Free Ebook


Post a comment