When trading in forex, one of the terms you’ll often come across is a pip or pips. Pips are an integral part of forex trading.
In this lesson, you’ll gain a better understanding of pips and the role they play in forex trading.
Lesson Highlights
- A pip is the smallest whole-unit movement prices can make, usually in the fourth decimal place.
- Brokers typically use four decimal places to display exchange rates.
- Traders make profits in the forex market from the differences in currency pair prices.
Defining Pips in Forex
Pip is short for “point in price” or “price interest point.” It refers to the smallest whole unit of movement a price can make in forex.
Most currency pairs (e.g., USD/AUD, USD/CAD, GBP/USD) list prices up to four decimal places. For instance, the USD/AUD exchange rate might be listed as 1.3578. If the price moves from 1.3578 to 1.3579, the smallest movement (0.0001) represents one pip.
This rule is applied to most currency pairs. The Japanese yen is an exception to this rule.
Currency pairs involving the Japanese yen always quote the yen with only two decimal places. If the USD/JPY moves from 110.50 to 110.51, it shows a one-pip movement.
Pips and Pipettes
Another term you’ll often read alongside pips is pipettes. When brokers use five decimal places (and three for the Japanese yen) instead of the usual four, the smallest possible whole-unit movement is called a pipette.
For example, if the GBP/USD moves from 1.30462 to 1.30463, the 0.00001 upward movement is one pipette. The same is true if the USD/JPY goes from 110.203 to 110.202.
How to Calculate the Value of Pips
Three factors affect the value of pips: the currency pair, the exchange rate, and the trade value.
Let’s say that you’re trading a EUR/USD currency pair at an exchange rate of 1.1500, and you are trading one standard lot (100,000 units) of the pair. You can determine trade value by multiplying lot size by the current market price.
Thus, you will have
Currency pair: EUR/USD
Exchange rate: 1.1500
Trade value: USD 115,000
To calculate the value of each pip in this trade, you can use the following formula:
Pip value = (one pip / exchange rate) * lot size
Using this formula, we can determine that
(0.0001 / 1.1500) * 100,000 = 8.70
This means you’ll either gain or lose USD 8.70 for every pip movement in your trade, depending on the movement’s direction.
Pips and Profits
As you’ve learned in the section above, currency pair price movements affect how much you could lose or profit from a trade. For instance, if you are buying the EUR/USD pair and the price of the euro increases relative to the U.S. dollar, you can make a profit if you exit your trade while the price increase holds.
Suppose you bought the euro at 1.2312 and exited when the price reached 1.2377. Using the pip value from the earlier example (USD 8.70 per pip), you will have profited USD 565.50 from the 65-pip upward movement.
These examples show how profits can snowball from less than USD 10 to hundreds of dollars with each additional pip movement. Imagine how much profit you could make if you’re trading by the millions!
You came across the term “lots” a couple of times in this lesson. In the next lesson, you’ll learn more about lots and how they affect your trades.
