What is a Pip in Trading Forex?

What is a Pip?

A pip is short for point in percentage, is a very small measure of change in a currency pair in the forex market for calculating profits and losses. It is specifically used in calculating the change in value between two currencies. It can be measured in terms of the quote or in terms of the underlying currency. A pip is a standardized unit and is the smallest amount by which a currency quote can change. It is used by different traders with different styles of trading. It is usually $0.0001 for U.S.-dollar related currency pairs, which is more commonly referred to as 1/100th of 1%, or one basis point. Pips are the smallest denomination traders can trade with when it comes to trading currencies and that they generally work to 4 decimal places ie: 1.2312 (the notable exceptions are the Yen pairs which work to 2 decimal places ie: 141.70. 

This standardized size helps to protect investors from huge losses. For example, if what is a pip was 10 basis points, a one-pip change would cause greater volatility in currency values. Understanding what is a pip allows Traders to use pips to reference gains, losses, calculate a trading opportunity or quantify a major trading reversal.

When calculating what is a pip, you use the last decimal point. Since most major currency pairs are priced to 4 decimal places, the smallest change is that of the last decimal point which is equivalent to 1/100 of 1%, or one basis point. For a trader to say "I made 40 pips on the trade" for instance, means that the trader profited by 40 pips. The actual cash amount this represents depends on the pip value.

In all pairs involving the Japanese Yen (JPY), a pip is the 1/100th place - 2 places to the right of the decimal. In all other currency pairs, a pip is the 1/10,000 the place - 4 places to the right of the decimal.

Determining Pip value

The monetary value of what is a pip depends on three factors: the currency pair being traded, the size of the trade, and the exchange rate. Based on these factors the fluctuation of even a single pip can have a significant impact on the value of the open position. Any trading mistake will therefore need to be minimised quickly!

Some Pip examples

Assume that we have a USD/EUR direct quote of 0.7747. What this quote means is that for US$1, you can buy about 0.7747 euros. If there was a one-pip increase in this quote (to 0.7748), the value of the U.S. dollar would rise relative to the euro, as US$1 would allow you to buy slightly more euros.

The effect that a one-pip change has on the dollar amount, or pip value, depends on the amount of euros purchased. If an investor buys 10,000 euros with U.S. dollars, the price paid will be US$12,908.22 ([1/0.7747] x 10,000). If the exchange rate for this pair experiences a one-pip increase, the price paid would be $12,906.56 ([1/0.7748] x 10,000). In that case, what is a pip value on a lot of 10,000 euros will be US$1.66 ($12,908.22 - $12,906.56). If, on the other hand, the same investor purchases 100,000 euros at the same initial price, the pip value will be US$16.6. The pip value increases depending on the amount of the underlying currency (in this case euros) that is purchased.

Example 2: GBP/JPY = 123.00

Here's another example showing what is a pip using a currency pair with the Japanese Yen as the counter currency.

Notice that this currency pair only goes to two decimal places to measure a 1 pip change in value (most of the other currencies have four decimal places). In this case, a one pip move would be .01 JPY.

(The value change in counter currency) times the exchange rate ratio = pip value (in terms of the base currency)

[.01 JPY] x [1 GBP/123.00 JPY]

Or simply as:

[(.01 JPY) / (123.00 JPY)] x 1 GBP = 0.0000813 GBP

So, when trading 10,000 units of GBP/JPY, each pip change in value is worth approximately 0.813 GBP.

Calculating Pip Value in your currency

Few people have their account denominated in the same currency. This means that what is a pip value will have to be translated to whatever currency our account may be traded in.

This calculation simply requires multiply/divide the "found pip value" by the exchange rate of your account currency and the currency in question. If the "found pip value" currency is the same currency as the base currency in the exchange rate quote:

Using the GBP/JPY example above, let's convert the found pip value of .813 GBP to the pip value in USD by using GBP/USD at 1.5590 as our exchange rate ratio.

If the currency you are converting to is the counter currency of the exchange rate, all you have to do is divide the "found pip value" by the corresponding exchange rate ratio:

.813 GBP per pip / (1 GBP/1.5590 USD)

Or

[(.813 GBP) / (1 GBP)] x (1.5590 USD) = 1.2674 USD per pip move

So, for every .01 pip move in GBP/JPY, the value of a 10,000 unit position changes by approximately 1.27 USD.

How traders can use pip movement to their advantage

A "pip" is the smallest denomination a foreign exchange trader can trade in. A fx trader can speculate whether their chosen currency pair is going to go up or go down in value. They will go "long" (buy) the currency if they suspect that it will go up in value against the currency it is paired with. A trader will go "short" (sell) if their analysis suggests it could go down in value.

If the trader speculates that the currency will increase in value against the currency it is paired with and the market proves them right, they will make a profit from the number of pips x their stake size (how much money they risked per pip) from the point they entered the market to the point when they decided to exit the trade.

However, if they are wrong and the market goes in the opposite direction, the trader will make a loss. This loss will be the: number of pips the market has gone against them x their stake size, from the point they entered the market to the point when they decide to exit the trade. A good trader will accept that they are not right all of the time so will safeguard against excessive losses by using effective risk management techniques.

 Example 1: What is a pip?  Selling the Australian Dollar V the US Dollar (AUDUSD)

The  example (above) shows a typical trading opportunity which we would trade. The sell signal was a  bearish pin-bar reversal on the AUDUSD weekly chart. This has closed after a pullback. This has given us the opportunity to sell the rally in a downward trending market.

As per our trading strategy, we would place our sell order at the break of the pin bar's low (0.7558) and have a protective stop loss above the tail (0.7676). After all, there is no guarantee the trade would have gone in our favour despite being a good set-up! Our first profit target would be the previous low (0.7416).

Supposing the distance (in pips) between our entry price and take profit one level (TP1) is:

Entry Price level  (0.7558) - Take profit 1 level (0.7416) = 142 pips profit.

If we had risked, say £10 per pip, that would be a total of £1,142 profit! 

 Example 2:  What is a pip?  Buying the Australian Dollar V the Canadian Dollar (AUDCAD)

The above example shows a bullish set-up which we took in May 2018. Our buy signal was a bullish pin bar on the AUDCAD weekly chart. This was closed as an "inside bar" having rejected a level of support (a buy level). As this set-up occurred at the bottom of a range, it gave us a good opportunity to simply buy the bottom of a well-established range!

The rules of our reversal trading strategy dictated that we should place our buy order at the break of the inside bar's high (0.9689), with our stop loss below the low (0.9588) and our profit target was the next level of resistance (0.9915).

Supposing the distance (in pips) between our entry price and take profit level is:

Entry Price level  (0.9689) - Take profit  level (0.9915) =  226 pips profit.

Supposing we had s stake size of  £20 per pip, that would be a total of £4,520 profit! 

How are other asset classes measured:

In explaining what is a pip, we should also mention how other asset classes are measured. Major stock markets such as the Dow Jones in the US or the FTSE100 in the UK are measured in points. Each point is worth a dollar for US stock markets or a pound for the FTSE. Increasingly major stock markets are quoted in % with a move of more than 1% seen as newsworthy.

Precious metals, such as gold, are measured in (troy) ounces. A troy ounce was originally used in Troyes, dates back to the Middle Ages. It is the standard unit of measurement in the precious metals market to ensure purity standards are maintained. The Oil price is quoted in dollars… both oil prices! Although Brent is seen as the more important price, WTI crude is also regularly quoted.

In financial markets trading, even the smallest changes in an asset price can affect trading strategy: be it Forex, equities, commodities, bonds or crypto-currencies. Although what is a pip is a very small measure of change it is important when selecting profitable trading opportunities. This is demonstrated by Example 1 and 2. Understanding what you are trading and how to calculate should be prioritised so you become the better trader!