What Is A Pip In Forex Trading?
Pip is an acronym for “price interest point” or “percentage in point”, which is a price change of 1/100 of 1% or one basis point. This represents the smallest possible change in an exchange rate.
The majority of Forex pairs are quoted up to 4 decimal places i.e. a pip is the last of those 4 decimal places. JPY pairs are the biggest exception since these exchange rates are measured up to 2 decimal places i.e. a pip is the 2nd decimal place.
Pips are the standardized unit of measurement in the Forex market because ultimately a trader’s profit or loss is based on the difference between the opening and closing price.
But why do pips matter? Let’s get into it.
How are pips calculated?
Since currencies are exchanged in pairs, the result of the trade is determined by the difference between the opening and closing prices. This difference is measured in pips.
For example – If you buy EURUSD at 1.1200 and close the position at 1.1300, that equals a 100 pip profit.
If you sell AUDUSD at 0.7050 and close the position at 0.7100, that would be a 50 pip loss.
How profit or loss is calculated?
It doesn’t get any easier than this, just multiply the volume of your position by the difference between the opening and closing prices. Remember to use the actual value of the position and not the margin (without leverage).
Using the examples from the previous section:
- EURUSD – 0.01 x 100000 = $1000 profit.
- AUDUSD – 0.005 x 100000 = $500 loss.
Each fluctuation in pips results in a change in your profit or loss, the $ amount is dependent on 3 factors:
- Currency pair being traded.
- Volume of the position.
- Exchange rate at the time.
The formula for this calculation is rather simple – Total value of the position x Price change
Let us use EURUSD as an example again – 100000 x 0.0001 = $10 i.e. each pip equals $10.
AKA “fractional pips” or “points” are 1/10 of a pip. Pipettes were introduced to allow for tighter spreads therefore decreasing trading costs.
On most pairs, this adds a 5th decimal place and a 3rd on the Yen pairs.
How to view price changes on your trading platform
On MT4, you can easily calculate price moves by dragging the crosshair tool from the low to the high ad visa-versa.
NB – MT4 shows market movement in points by default, so make sure you do not overestimate.
Grab the measurement tool from the left column, then drag the bottom and top lines to correspond with the high and low of the price move.
Open your chart in full-screen mode, select the drawing tools dropdown, and then the measurement tool.
Draw the line vertically to connect the relevant swing points and you will see the size of the market move (pips) in the top left corner.
Pips are the most basic form of measurement in Forex trading, so make sure you know them like the back of your hand.
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May 2021 be a prosperous year for you.
Risk disclosure – Trading CFD’s carries risk, losses can exceed deposits.
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