What are Pips and How It Is Used in Forex?

Pips, one of the frequently used terms in trading, is something you have probably heard too. But have you ever wondered –What are pips? And how it is crucial for forex trading. If not, don't worry; we are here for you. For your assistance, we have come up with detailed information regarding 'Pips' and its importance in Forex trading. Have a look!

A pip, often referred to as Percentage in Point, is a unit of measurement for a price change in an exchange rate. The change in value assists traders in managing their trading strategy by allowing them to enter or alter orders.

Pips are commonly used to denote losses and profits. The last decimal point is used to calculate a pip, representing a currency pair's changed exchange rate value.

What are Pips?

In simple words, the change in the value of two currencies is usually stated in pips. A pip is the 4th decimal point of a price, which is equivalent to 1/100th of one percent in most currency pairs.

For instance, if the value of GBP/USD has changed from 1.4000 to 1.4001, it is considered to be moved by one pip. But in a rare scenario, currency pairing with the Japanese yen (JPY) is only quoted to two decimal places. In this, a pip represents a 0.01 price fluctuation.

If you're still confused about what are pips? Take another example; if the value of the GBP/JPY pair moves from 150.00 to 150.05, it is considered to be moved by 0.5 pips.

How Pips are used in Forex Trading?

Pips play a vital role in forex trading as the price movements of currency pairs are the basis for forex trading. Pips are the most common means of calculating such changes. Rather than representing a currency's actual value, pips reflect changes in units, which can then be readily converted into alternative currency values.

There are two methods for calculating received payouts in Forex trading. Firstly, calculate them in actual currencies. Secondly, use a pip formula. The latter is preferred by many traders as it is more accurate and easier to understand.

Apart from calculating profits and losses and price changes, pips can also help traders manage risk and estimate the proper leverage to utilize. For instance, a trader can place a stop-loss order to specify the maximum number of pips he is ready to lose on a transaction. If the currency pair moves in the wrong direction, a stop-loss will probably limit a trader's losses.

How to Calculate the Pip Value?

The actual amount of profit or loss generated by each pip of movement is determined by its value. To understand how to calculate pip value, the three important things that a trader should know: traded currency pair, the spot price, and the trading amount.

The formula for calculating pip value:

For a four-decimal currency pair, the formula for calculating the pip's value is:

(0.0001 x trading amount) / Spot price = pip value

Learn more about pip value calculation with the following examples.

• 1.. If a trader buys 10,000 euros against USD (EUR/USD) at 1.10550

Suppose the EUR/USD exchange rate has risen to 1.10650. In this case, one pip represents a 0.0001 movement. Thus, the trader has gained a profit of 10 pips (1.10650 – 1.10550 = 0.0010, or 10 pips).

• 2.. If a trader buys 10,000 euros against USD (EUR/USD) at 1.10550

Imagine, the EUR/USD exchange rate has fallen to 1.10450. In this case, one pip represents a 0.0001 movement; thus, the trader has incurred a loss of 10 pips (1.10550 – 1.10450 = 0.0010, or 10 pips).

What causes changes in pip values?

The pip value of different currency pairings is determined by the base value of a trader's account. For example, if USD is the second (quote) currency in the currency pair, then the pip value on a normal lot, mini lot, and micro lot will be $10, $1, and $0.10, respectively.

The value of pip will change in only one circumstance, which includes if USD was the initial (base) currency in the currency pair or not involved in the pair, and if the value of USD fluctuated considerably by more than 10% in any direction.

What are the methods to calculate Pips for currency pairs?

Pips are used by both traders and brokers to compute the profits or losses. There are three basic methods for calculating pips for currency pairs:

• Pips for the majority of pairs (0.0001)

• Pips for JPY pairs (0.01)

• Nano pips

Pips for the majority of pairs:

To understand this method, let's take the stable currency pairings, such as USD/CNY or EUR/USD; both use a different pips calculation approach. A pip is the fourth decimal position after the decimal point - 0.0001. Above, we have used this method: the fourth number from the decimal point in 1.0004 is 4; hence a change of 0.0001 at that place means one pip. The trader would earn 2 pips (4-2=2) if the selling price was 1.0004.

Pips for JPY pairs:

Although most currency pairings use the method described above, one set of currency pairs uses a slightly different way. For currency pairs with the Japanese yen, pips are calculated using this approach. The USD/JPY pair, for example, determines pips using the second number from the decimal point rather than the fourth.

Nano pips:

This type of method is less used and not so popular in forex trading. However, it is more precise than the others mentioned above. It's referred to as a "pipette" or "nano pip." In this method, the pip represents the price movement of the fifth number after the decimal point rather than the fourth.

Conclusion:

As we are ending this topic, here's a quick conclusion about what are pips? A measuring unit used by forex traders to track price changes and profit and loss is what pips are all about. Apart from this, it plays a significant part in managing the risk of traders, as well. For instance, a trader can set a pips-based stop-loss for a trade, limiting the possible losses if you're about to lose the trade. In addition, pips can assist forex traders in determining the most suitable position size, ensuring that they are not incurring unnecessary risks by initiating positions that are too large and risky.

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