What Is a Pip?
"Pip" is an acronym for percentage in point or price interest point. A pip is the smallest whole unit price move that an exchange rate can make, based on forex market convention.
Most currency pairs are priced out to four decimal places and a single pip is in the fourth decimal place (i.e., 1/10,000th). For example, the smallest whole unit move the USD/CAD currency pair can make is $0.0001, or one pip.
Pips, which are used in forex trading, should not be confused with bps (basis points) used in interest rates markets that represent 1/100th of 1% (i.e., 0.01%).
Key Takeaways
- Forex currency pairs are quoted in terms of pips, short for percentage in points.
- In practical terms, a pip is one-hundredth of one percent (1/100 x .01) and appears in the fourth decimal place (0.0001).
- It is the smallest price change increment for most forex pairs.
- The bid-ask spread of a forex quote is typically measured in pips.
Understanding Pips
A pip is a basic concept of foreign exchange (forex). Forex traders buy and sell a currency whose value is expressed in relation to another currency. Quotes for these forex pairs appear as bid and ask spreads that are accurate to four decimal places.
Movement in the exchange rate is measured by pips. Since most currency pairs are quoted to a maximum of four decimal places, the smallest whole unit change for these pairs is one pip.
Calculating Pip Value
The value of a pip depends on the currency pair, the exchange rate, and the trade value. When your forex account is funded with U.S. dollars and USD is the second of the pair (or the quote currency), such as with the EUR/USD pair, the pip is fixed at .0001.
In this case, the value of one pip is calculated by multiplying the trade value (or lot size) by 0.0001. So, for the EUR/USD pair, multiply a trade value of, say, 10,000 euros by .0001. The pip value is $1. If you bought 10,000 euros against the dollar at 1.0801 and sold at 1.0811, you'd make a profit of 10 pips or $10.
On the other hand, when the USD is the first of the pair (or the base currency), such as with the USD/CAD pair, the pip value also involves the exchange rate. Divide the size of a pip by the exchange rate and then multiply by the trade value.
For example, .0001 divided by a USD/CAD exchange rate of 1.2829 and then multiplied by a standard lot size of 100,000 results in a pip value of $7.79. If you bought 100,000 USD against the Canadian dollar at 1.2829 and sold at 1.2830, you'd make a profit of 1 pip or $7.79.
JPY Exception
Japanese yen (JPY) pairs are quoted with 2 decimal places, marking a notable exception to the four decimal place rule. For currency pairs such as the EUR/JPY and USD/JPY, the value of a pip is 1/100 divided by the exchange rate. For example, if the EUR/JPY is quoted as 132.62, one pip is 1/100 ÷ 132.62 = 0.0000754. With a lot size of 100,000 euros, the value of one pip (in USD) would be $7.54.
Fractional pips are smaller than pips and, thus, a more precise measurement. They appear as a superscript numeral at the end of a quoted exchange rate. A fractional pip, or "pipette," is 1/10 of a pip.
Pips and Profitability
The movement of the exchange rate of a currency pair determines whether a trader makes a profit or loss at the end of the day. A trader who buys the EUR/USD will profit if the euro increases in value relative to the U.S. dollar. If the trader bought the euro for 1.1835 and exited the trade at 1.1901, they would make 66 pips on the trade (1.1901 - 1.1835).
Now, let's consider a trader who buys the Japanese Yen by selling the USD/JPY pair at 112.06. The trader loses 3 pips on the trade if they close out the position at 112.09. They profit by 5 pips if they close it out at 112.01.
While the difference may look small, in the multi-trillion dollar foreign exchange market, gains and losses can add up quickly. For example, on a $10 million position that closed at 112.01, the trader would make ¥500,000. In U.S. dollars, that's $4,463.89 ( ¥500,000/112.01).
Real-World Examples of Pip
A combination of hyperinflation and devaluation can push exchange rates to the point where they become unmanageable. In addition to impacting consumers who are forced to carry large amounts of cash, this can make trading unmanageable and the concept of a pip loses meaning.
A well-known historical example of this took place in Germany's Weimar Republic, when the exchange rate collapsed from its pre-World War I level of 4.2 marks per dollar to 4.2 trillion marks per dollar in November 1923.
Another case in point is the Turkish lira, which reached a level of 1.6 million per dollar in 2001, which many trading systems could not accommodate. The government eliminated six zeros from the exchange rate and renamed it the new Turkish lira. As of January 2021, the average exchange rate stands at a more reasonable 7.3 lira per dollar.
What's a Pip?
A pip is the smallest whole unit measurement of the difference between the bid and ask spread in a foreign exchange quote. A pip equals 1/100 of 1%, or .0001. Thus, the forex quote extends out to four decimal places. Smaller price increments are measured by fractional pips, or "pipettes."
What Is the Difference Between a Pip and a Pippette?
In the context of the foreign exchange market, a pip is a standard unit of measure for changes in an exchange rate, representing a move of 0.0001 (1/10,000). This is the smallest price change increment for most currency pairs.
A pipette equals 1/10 of a pip and it represents a fraction of 1/100,000.
A pip, therefore, relates to movement in the fourth decimal place, while a pipette is used to measure movement in the fifth decimal place.
How Are Pips Used?
They are a part of a currency pair's exchange rate market quote. Pips represent the change in the quote and value of a position in the market you may have taken. Say, hypothetically, you bought a currency pair for 1.1356 and sold it for 1.1360. You made 4 pips on your trade. You'd have to then calculate the value of a single pip and multiply that by your lot size for the dollar value of your profit.
Does the Japanese Yen Forex Rate Use Pips?
Yes, it does. However, the yen is an exception. A quote for the yen normally extends two decimal places past the decimal point. So, a single whole unit pip is .01 rather than the .0001 for other currency pairs.
What Is the Spread in a Forex?
The forex spread is the bid price subtracted from the ask price of a currency pair. For example, if EUR/USD has an ask price of 1.1053 and a bid price of 1.1051, then the spread is 0.0002 or 2 pips.
To calculate the cost of the forex spread, you need to multiply the spread by the trade size or volume. For example, if you trade 100,000 units of EUR/USD with a 2-pip spread, then the cost of the spread is $20.00 = (0.0002 x 100,000).
The Bottom Line
The concept of pips is fundamental in the forex market and serves as a significant basis for making trading decisions. A pip, or Percentage in Point, is a basic measure used in the forex market for currency movements. It is typically the smallest price move that a given exchange rate makes based on market convention. Understanding pips is crucial for forex traders as it allows them to quantify the value of their potential gains or losses, and manage their leverage and risk accordingly.
As a seasoned expert in the field of foreign exchange (forex) trading, I bring a wealth of knowledge and experience to the table. Having navigated the intricate world of currency pairs, pips, and trading strategies, I can confidently provide valuable insights into the concepts discussed in the article you provided.
The article delves into the fundamental concept of a "pip," which stands for "percentage in point" or "price interest point." It's the smallest whole unit price move that an exchange rate can make, commonly measured to four decimal places. The USD/CAD currency pair, for instance, moves in increments of $0.0001, or one pip.
Understanding the practical implications of pips is crucial for forex traders, as these movements play a pivotal role in determining profits or losses. The bid-ask spread, quoted in pips, is a key factor in assessing the cost of trading.
The article further explores the calculation of pip value, emphasizing its dependence on factors like the currency pair, exchange rate, and trade value. Whether the USD is the base or quote currency influences the formula for pip valuation.
A noteworthy exception to the four-decimal-place rule is presented in Japanese yen (JPY) pairs, which are quoted with two decimal places. The article explains the unique calculation for pip value in JPY pairs.
Real-world examples illustrate the significance of pips in the context of currency fluctuations. The historical cases of hyperinflation in Germany's Weimar Republic and the Turkish lira's extreme devaluation underscore the impact on exchange rates and the challenges traders may face.
Additionally, the article touches on fractional pips, or "pipettes," providing a more precise measurement for smaller price increments. It emphasizes the role of pips in determining the profitability of trades and showcases scenarios where gains and losses can accumulate rapidly in the vast foreign exchange market.
To sum it up, the concept of pips is fundamental in forex trading, serving as a crucial measure for currency movements. This understanding allows traders to quantify potential gains or losses, manage leverage, and make informed decisions in a dynamic market. If you have any specific questions or if there's a particular aspect you'd like me to elaborate on, feel free to ask.
