What Is A Forex Pip?
When you start to look around forex websites online, you will soon see references to the forex pip. Your gains and losses will be measured in pips. Something else that is measured in pips is the spread, the difference between the bid and ask prices which is the main cost of forex trading and how the brokers make their money. So it is clearly very important to understand what is a forex pip.
The word is an acronym standing for percentage in point (or sometimes, price interest point). It is the smallest increment of changes in values. It allows us to measure a rise or fall in currency values in percentage terms instead of in dollars and cents.
Why do we need to talk in pips?
The reason for this is simple. In the foreign exchange market there is no world currency in which to express values. The US dollar may be the most commonly traded currency but it is not involved in all trades. If you are trading cross rates, i.e. two other currencies such as EUR/GBP or any other combination that does not involve USD, it would not make any sense at all to express your gains and losses in terms of US dollars. Instead, we need something that is a small percentage of the value of whatever currencies we are dealing with.
This means that the monetary value of a pip varies according to the currency.
Most currencies are quoted to four decimal points. For example you might see the bid price for EUR/USD quoted at 1.3642 and ask price 1.3644. The difference (the spread) is 0.0002 or 2 pips. Here a pip is 0.01% of a lot.
So if the lot size was $100,000, one pip would be worth $10. For a lot size of $10,000, one pip would be $1.
That is the value of pips when the US dollar is the quote currency, i.e. XXX/USD. But when the quote currency is different, one pip is usually 10 units of that currency (e.g. 10 euros or 10 pounds). Or if your lot size is 10,000 units, one pip is 1 unit (1 euro or 1 pound).
The exception is the Japanese yen which has a much lower unit value than most currencies (you get a lot of yen to the dollar). Because of this, the yen is only quoted to the second decimal point. You might see a price USD/JPY 110.15. In this case one pip is 0.01 or 1% but in yen, not dollars. So the pip value is JPY 1000 which at that price would be worth US $11.015.
These differences can be confusing when you are just starting out. So it is better for beginners to trade consistently with just one currency pair.
If you are trading one pair regularly every day you will soon get used to how much a pip means in terms of your actual gains and losses in your account. You will know how much one pip is worth in dollars or in your own currency.
But when you are trading several different currency pairs, you have to deal with pips of different value. If you get confused, you could be taking greater risks than you planned or closing trades with less profit than you thought. It is much easier to deal with only one pair at first until you have a sound understanding of trading practices and forex pip values.