What is a Pip in Forex? – FX Guide

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You have probably heard about the term pip in the Forex Market, and even if you haven’t, don’t worry. We are here to introduce you to this while offering you an insight into what is a pip in Forex. We will also discuss how you can calculate its value within minutes.

This article aims to provide a comprehensive understanding of the measuring unit pip, its fundamental function, working, profitability, importance, and above all, the method of calculating the pip value. So, let’s delve into detail and learn about what role pip plays in the Forex market.

Defining a Pip

Pip refers to the short form of percentage in point, or to say, price interest point. It is the smallest measuring unit and denotes the small change in the Forex currency. The traders can measure it in either quote or as the currency amount.

It represents the smallest unit or the last digit from the right of the four decimal places. However, it causes the most change in the Forex market with the slightest price change. It means, even a difference of one point in pip can decide the degree of the trader’s profit and loss in the Forex market.

Unlike other currencies, the pip value of the currency pair involving the Japanese Yen is the second decimal point instead of the fourth from the right. Pip forms a building block of the Forex exchange market by highlighting the smallest or minor change in the price action or market’s movement.

Therefore, pip stands as the most notable measuring unit in the Forex market for representing the change in currency pair. Therefore, a comprehensive understanding of the calculating Pip value is significant for becoming a professional Forex currency trader.

For example: if the traders have USD/EUR Forex currency pair with a quote of 0.6748 per US dollar. It means that the buyers can buy this quote for $1. Consider a one pip change in the quoted amount that becomes 0.6749. It changes the US dollar’s value relatively, letting you buy more Euros.

So, the change in pip’s value influences the US$ according to the purchased Euros. Forex traders can buy 0.6748 Euros for $1 and 10,000 Euros for $14,819.20. After experiencing a one pip change in exchange policy, this amount will become $14,817.00.

It makes 10,000 Euros for relatively $2.2, and if the Forex trader wants to buy 20,000 Euros on the same quote value of 0.6748, he has to pay the pip value of $4.39. So it shows that the increment in pip’s value is directly proportional to the amount of quote or underlying currency like Euro, in this case.

Calculation of pip value

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As defined by the earlier example of 0.6748 quote value, it follows the formula: [(1/0.6748) x10,000]. It means the traders have to divide the present currency value in the Forex market with the initial pip value and then multiply it with the amount you want in return.

In the example of USD/Euro, we have taken 0.6748 as an initial quote pip value and the US market rate as $1. It means that the traders will get 0.6748 Euros for $1 or $1=0.6748. If they want to buy more Euros, like, 10,000 or 20,000 or 100,000, they can multiply this lot amount with (1/0.6748).

In this way, the increase or decrease in the pip value as low as one pip only affects the overall market rate of the Forex currency pairs. Thus, the difference between the bid and the asked price represents the profit and loss of the Forex trader.

In short, the base formula for calculating pip value on the initial quote amount is one pip price divided by the current market exchange rate. Then, multiply the result with the asked amount or the lot size. Remember, the 0.0001 % change in the currency exchange value makes one pip.

The traders can calculate the final pip value after the initial market rate undergoes one pip change by subtracting the amounts. The formula of subtraction breaks down into [(1/0.6748)x 10,000] – [(1/0.6749)x 10,000].

The function of pip in the forex exchange market

As discussed earlier, pip is a price interest point used to measure the changes of currency pairs in the exchange rate. It measures the amount of exchange rate by examining the price movement in the Forex market. By using pip, you can also measure it in terms of the quote or underlying currency.

While trading in the forex market, it is significant to note the importance of pip value in the exchange market. The pip is a standardized unit. The pip is highly favourable in representing the smallest possible change in a currency quote.

As every currency has its value, the Forex traders have to calculate the value of a pip for the currency pair they want to trade. The pip is very easy to read. For example, if we take USD, which moves from 1.1049 to 1.1050. This 0.0001 change represents the increase in value, and it’s known as one pip.

There are some exceptions. The traders can identify the big difference between the one pip value of the Forex currencies due to the different exchange rates. So, the one trader trading USD/EUR pair and the other USD/CAD currency pair has to calculate pip values separately and get different outcomes.

If you want to read a pip, you must focus on the last decimal point because the change in pip usually happens in the last decimal point of a price quote. This is because rates for participants in foreign exchange, which are paid when carrying out currency trade, are calculated with the respect to pips.

The currency which is used to open an account for trading also determines the value of the pip. Therefore, if other foreign currencies dominate your financial account instead of USD, you can still apply the same pip value according to the lot sizes.

That makes, if EUR is the quote in the Forex currency pair, then the pip value is 10 Euros as per your underlying currency, etc. If it isn’t the quote, then the traders simply have to divide the initial value of the pip with the exchange market rate of the Euro and the quote.

Brokers are compensated by the spread between the price the seller receives and the price the buyer pays. The spread is all about how your dealer is making money. During the trade, the value of the pip can vary a lot on your lot size.

Pips can produce solid profit in your trade if you have enough knowledge of when to buy or to sell the currency pair, according to their rate changes. However, it is easy to make 40 pips or 50 pips per day compared to 100 pips per day which can be very challenging for any trader if they want to.

Forex brokers sometimes quote currency pairs with decimal places of 5 to 3 instead of the standard 4 to 2. According to their quote, they refer to FRACTIONAL PIPS, also known as pipettes which is a tenth of the pip.

Profit gain and pip

Pip can be very profitable for foreign exchange traders if they have enough knowledge and experience about quote currency. The profit or loss per pip depends on the quoted currency. Each pip translates into $10, which can produce a solid profit to your account if it moves in your favour.

Similarly, it can also suck your account if the value of pip doesn’t move in your favour which can cause great damage of $10. In most cases, the four-pip spread has the highest pip value. Two pairs exhibit the best ratio, which is GBP/USD and EUR/JPY.

Often the traders complain of being unable to make 100 pips per day which equals USD 10.00, and, in actuality, it is about saving pips. However, if you are an experienced foreign exchange trader, you can make it easier and make your account healthy. Moreover, it will be very profitable if you invest your money in the right currency.

For example: consider the USD dollar or Japanese yen. The Japanese yen is very popular among traders because of its outcomes. It is considered a safe haven by most traders in the foreign exchange market.

Pips can be very useful for traders if they work according to the breakout strategy. It means that when price breaks above a range, traders should go long, and similarly, if price breaks below a range, traders should go short.

How does pip work in the forex market?

Usually, the currency rates are expressed up to four decimal numbers. The last digit or the fourth digit in the four decimal point denotes pip value that refers to the smallest change in the price movement as one pip.

It expresses the movement of the Forex currency exchange rate that the traders then trade. Pip measures the smaller movements in the currency exchanges rates, thus establishing the structure of the Forex exchange market.

If the trader wants to trade the currency pair of USD/EUR, he will buy US dollars and sell Euros or buy Euros and sell US dollars simultaneously. For this, he requires extensive knowledge about the exchange rates and their movements thus of pip.

Pip analyzes the smaller to smallest changes and allows the traders to determine the ideal trading position in the market. Therefore, the traders use this term pip to express currency spread. Here the term spread refers to the price difference between the bid and ask prices.

As mentioned earlier, the highest security price that the buyers pay is known as the bid price, and the lowest security price that the seller agrees to take is the ask price in the Forex market. The liquidity of the security asset also depends on this spread. The smaller spread difference makes the security more liquid.

While pip identifies the market spread, it also provides an insight into how much the traders would gain or lose by trading in this market. This is because the smaller spread calls for no change in the exchange rate between the opening and closing of the trade. Thus the trader earns a profit.

The pip value is different for different currency pairs because of the different exchange rates. Yet, the formula for calculating the pip value is the same. Only in the case of the Japanese Yen, the second digit from the right in the decimal point indicates the pip value because its currency value is usually smaller.

Why is calculating pip important in the forex market?

3d renderof computer keyboard with buy and sell buttons

Pip helps in measuring the exchange rate in the Forex market. As mentioned above, it stands at fourth place at any decimal point. Thus, the traders can calculate the pip value of any currency that they want to trade.

This mathematical work is significant to calculate the values, although it is usually calculated automatically in the forex market. Trading is a fun game until the traders gain profit and don’t become prey to the risk or scams.

Therefore, it is preferable to calculate the pip value by yourself to have the hands-on information even if your broker has calculated it for you. It can not only help in avoiding scams but also aids in examining the price movement and the Forex market structure.

It marks its importance when the traders open and close trading at the same pip value like started trading EUR/USD at 1.0000 and closed at the same value as it calls for profit gain. Therefore, calculating pip value beforehand can help in making calculated investments avoiding greater risk.

Through the pip value, the traders can examine what they are risking for profit and if the risked value is relative to the gained rewards. Thus, calculating pip value beforehand saves the traders from wiping out their entire fortune by helping them in doing informative trading.

Bottom line

Pip forms a building block of the Forex market by indicating the smaller changes in the exchange rate. The term pip stands for percentage in points, so it is already clear that it measures the amount of the exchange rate by using the last decimal point.

It means that it notes the movement of currency exchange and expresses it through the last digit of four decimal points. It can be calculated automatically and manually by using the easiest formula. However, a detailed understanding of pip is necessary to examine the Forex currency’s movements.

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