What Are Pips In Forex Trading?

When trading in the Forex market, it’s definitely not advisable to undervalue the significance of pips. A pip, which commonly stands for either “price interest point” or “percentage in point,” basically represents the very small price activity a currency pair can have in the market at any moment.

For most currency pairings or tandems—including, for instance, the U.S. Dollar/British Pound (USD/GBP)—a pip is equivalent to 1/100 of a percentage point, or one basis point, and pips are gauged in the fourth spot behind the decimal in price quotations. However, for currency pairings involving the Japanese Yen, on the other hand, each pip represents one percentage point, and they are gauged in the second place behind the decimal in price quotes.  

After all, currencies need to be exchanged in order to facilitate business and international trade. And as you already know, the foreign exchange or Forex market is the place where such dealings happen together with bets made by Forex traders who anticipate making money off price movements of pairs of currencies. Pips are an essential part of the equation here as they are used for calculating the rates parties in the Forex market pay when carrying out such currency trades.

If you’re interested in becoming a Forex trader but can’t wrap your thoughts around what pip means in Forex and understand the whole meaning of what are pips in Forex trading, don’t worry because we’ve got you covered. Below, we’ll explain everything there is around pips so that you can understand the importance of measuring the fluctuation of prices in different currencies and enjoy successful Forex trading.

What Exactly Are Pips In Forex Trading?

In Forex market trading, the final decimal point in price quotes is the slightest, most minor price shift that might happen. So, considering that most prominent currency pairs, like those involving EUR, GBP, and USD, are evaluated to 4 decimal spots, a pip, in this case, is the tiny price movement or activity of 0.0001.

So, for instance, if EUR/USD progressed from 1.0900 to 1.0901, it has advanced by a single pip. Comparably, currency duos using the JPY or Yen are only cited to 2 decimal spots, so in those cases, a pip is an alteration of the price of 0.01.

Nowadays, you can trade through innovative financial instruments like trading CFDs, abbreviated for contracts for difference, and conduct spread betting on the Forex market. This comprises opening positions established on the projection that a given currency will get stronger compared to another. In that context, for every point that a currency’s value rises, it will result in gains or losses for you as a trader, relying on the market’s direction.

How To Calculate The Value Of A Pip

Now that you know what a pip is, what does a pip mean for traders regarding how much is a pip in Forex worth and how much profits they can make for every price oscillation? Well, it all hinges on the extent of the position they open in the Forex market.

More prominent positions mean that each pip activity in the given currency pairing will have a more significant monetary consequence on their balance. On a related note, traders should also bear in mind that most Forex brokers offer leveraged trading, implying that traders will need to consider the pip value of currency pairings altogether with the leverage provided by their Forex brokerage providers.

The good thing here is that calculating the pip is relatively simple, and we’ll explain it through a tangible example from the real trading world. Let’s say that you, as a trader, place a $150,000 long trade on USD/AUD at a time when it’s trading at 1.0554. In the meantime, the value of USD/AUD rises to 1.0574. In this example, since one pip is equivalent to the movement of 0.0001, you’ve made a profit of approximately 20 pips (1.0574 – 1.0554 = 0.0020, or 20 pips).

The method or formula used to calculate the real pip value for a 4-decimal currency pair is: Pip value = (0.0001 x trade amount) / spot price of the currency. Or in this case, the pip value in US dollars is (0.0001 x 150,000) / 1.0574 = $14.18. Finally, to figure the profit or loss, we simply calculate the number of pips accumulated times the value of each pip, or in this case, you made a profit of 20 x $14.18 = $283.

In Conclusion

As you can tell now, traders utilize pips to evaluate price trends in the foreign exchange market and calculate their profits or losses. Besides making basic calculations, pips also play a crucial role in Forex risk management.

In fact, an experienced trader can place a stop-loss for a given trade in the context of pips, limiting the possible losses on a losing trade. These points can also help traders accurately estimate the most advantageous position size to ensure they’re not taking disproportionate risks when opening too large positions with the prospect of significant, undesired losses.