What are Pips in Forex: Complete Guide for Beginners | What Does Pips Mean in Trading

2023.02.02 2023.02.02
What is a Pip in Forex trading? Definition and examples

Artem Shashkovhttps://www.litefinance.org/blog/authors/artem-shashkov/

This article will focus on the minimum price change known as pip. You will find out how much it is, why we measure price movements in them and whether the pip and pip value is the same for all trading instruments, including complex instruments such as CFDs wich come with significant risk. What can I say – there are pips and then there are other pips, and it’s important to understand the pips’ meaning.

Trading pip depends on many things, and a trader has to know what position size, basis point and pip move mean. Let’s try to find out!

Pips Definition & Meaning

I will not torment the reader with a long introduction. A pip is a general term for the minimum unit of price change. The term is mostly popular among Forex currency pairs traders because it’s inconvenient to calculate miniscule fluctuations of two currencies in dollars or euros. It’s easier to say that the price grew by 540 pips than 0.0054 euros, isn’t it?

An important detail about the FX pip is that it depends on the accuracy of the price measurement. Some brokers offer 4-digit quotes – here the accuracy of price measurement is limited to ten thousandths. In this case, the pip change of the fifth last decimal point in the EURUSD price – for example, from 1.00000 to 1.00004 – will go unnoticed. A one-pip change for a 4-digit Forex broker will equal a 10 pip change for a 5-digit quote.

Let us consider the spread for the EURUSD currency pair:

The exchange rate is 1.21232 to 1.21233:

• the best sell price is EUR 1.21232,

• the best buy price is EUR 1.21233.

The spread, or the difference between the quotes, is EUR 0.00001 or 1 pip. As you have probably guessed, LiteFinance provides 5-digit quotes. 

Speaking about the minimum price movements, let’s analyze how the price of this instrument (EURUSD) has changed during 5 minutes on a minute timeframe (M1).

The price is at the level of 1.21247.

After 10 minutes, the price increased slightly – to 1.21250.

The timeframe is small, that’s why the growth is so small

It turns out that the price has grown by 3 pips from 1.21247 to 1.21250 or by EUR 0.00003.

The pip value of 0.00001 is also called “fractional pip” because it is 1/10 of the “standard” value with a 4-digit quote. 

Calculating Pip value

To do this, we need to know:

• The cost of 1 lot of the traded instrument. In currency trading, it is usually 100,000 units of the base currency (which is the first in the quote). The second currency in the pair is known as the counter currency. For example, the cost of 1 lot of the EURUSD = 100,000 euros. The cost of 1 lot of the GBPJPY = 100,000 pounds, etc.

• The cost of the instrument. Let’s take EURUSD again. At an exchange rate of 1.20000, buying 1 lot (100,000 euros) will cost 100,000 x 1.20 = 120,000 dollars.

   

If we sell 1 lot at a price 1 pip value higher, i.e. by 1.20001, as a result of such a trading operation we get 100,000 x 1.20001 = 120,001 US dollars. Therefore, we can earn 1 dollar on a move of one pip, which is the cost of a single pip on this instrument.

Other instruments are calculated using the same method.

Let’s take the USDJPY as an example of unconventional 3 decimal digits in the exchange rate calculation.

Cost of 1 lot – USD 100,000

We’ll assume the exchange rate of the instrument is 105.300 

In the example with the dollar and the yen, the minimum price fluctuation would be 0.001 

When buying 1 lot of the USD/JPY, you need 100,000 * 105,300 = 10,530,000 Japanese yen. 

If the exchange rate rises by a single pip to 105.301, then 1 lot (100,000 US dollars as a base currency) can be sold at 10,530,100 yen (counter currency). 

Therefore, the trade value of one pip here will be 10,530,100 – 10,530,000 = 100 yen.

Finding Pip value in the trading account

Some of the pip values on the Forex currency pairs market can be found in the trading platform account. Let’s open a chart of the EUR/USD currency pair in the online terminal. To do this, select the “currencies” tab and click on the EURUSD pair (EUR – base currency, USD – counter currency).

The scale in the right corner of the chart shows the current price of the instrument. It sits at a value of $1.20241.

We have 5 decimal places, which means that the minimum price change for this instrument will be $0.00001. 

To calculate the trade value of one pip, you also need to know the volume of the transaction, which is measured in lots. The selected volume value is shown to the right of the chart:

As the volume of the transaction grows, the value of one pip for the trader also increases. As we found out earlier, with a volume of 1 lot, the cost of a pip is $1. This means that with a minimum volume of 0.01 lot, the cost of a pip will be equal to $ 0.01. In this case, the trader will be able to earn $0.5 on the price movement of 50 pips. 

If you increase the volume to 0.1, the cost of 1 pip will also increase 10 times – from $0.01 to $0.1. Then the same movement of 50 pips can bring the trader $5. 

It is crucial to understand that any trade always has two potential outcomes. So before playing with volumes, it is recommended that the trader should acquire basic knowledge of the risks involved and money management.

Major currencies pips: Forex

The major currency pairs are called the Majors. These include:

• EURUSD (Euro – US Dollar);

• USDCHF (US dollar – Swiss franc);

• GBPUSD (British Pound – US Dollar);

• USDJPY (US Dollar – Japanese Yen);

• USDCAD (US Dollar – Canadian Dollar);

• AUDUSD (Australian dollar – US dollar);

• NZDUSD (New Zealand Dollar – US Dollar).

   

All these instruments have 5-digit quotes, except for the USD/JPY, which has 3 last decimal points. 

The cost of 1 lot for each instrument is 100,000 units of the base currency (first in the quote):

Now let’s add 1 pip value for each currency pair and calculate its value for a standard volume of 1 lot.

Depending on the currency in which the trader keeps their trading capital, these values ​​will be converted based on the current rate. 

For the calculation you will need:

1. The cost of 1 pip of the traded instrument. For example, a trader is trading the USDCHF on the trading platform. Then the cost of 1 pip is measured in CHF  and is 1 CHF.

2. The exchange rate ratio of the account currency to the currency in which we’re calculating the value of 1 point. In our case, we need the USD (base currency) to CHF exchange rate.

For a trader’s account in USD, the cost of 1 point of the USD/CHF currency pair at its exchange rate of 0.90000 will be calculated as follows:

Point value for an account in USD (base currency) = 1 CHF / 0.90000 = 1.11 USD 

If a trader with an account in USD wants to trade the USD/JPY pair with the exchange rate 105,600, then the pip value for their account in USD will be as follows: 

Calculating the Forex currency pairs pip value for an account in USD = 100 JPY / 105,600 = 0.95 USD 

When you’ve mastered the basics of calculation, you can use the trader’s pip value calculator to save time:

Pips and price movement

Calculating the value of potential profit or loss is of practical importance for the trader’s analysis. Based on the pip values, the trader can calculate the trade volume that fits their risk management rules and trading capital, and thus mitigate the significant risk involved in Forex trading.

For such calculations you will need:

• calculate the value of a pip of a traded instrument in the account currency with a standard volume of 1 lot;

• calculate the possible loss in the account currency: how much the trader will lose when the stop loss is triggered. This can be done using the formula:

  Stop loss for standard volume (in account currency) = pip value in account currency x Stop loss value in pips

• Calculate the trade volume based on the risk management rules.

Suppose a trader is trading the EURUSD currency pair on a USD trading account. They want to place a stop loss of 20 pips with $200 of trading capital.

1. The cost of a pip with a volume of 1 lot = 1 USD

2. When setting a stop loss of 20 pips in the case of a 1 lot trade, the trader should take the high risk of:

   Pip value * Stop loss value in pips = $20

3. Suppose a trader does not want to risk more than 3% of the deposit per trade. With a capital of $200, this will be $200 * 0.03 = $6

If the stop loss with a volume of 1 lot is $20, then the trader will need to cut the trade volume: 

$20 / $6 = 3.33. 

Consequently, the trade volume with such risk management parameters should be 3.33 times less than the standard volume of 1 lot. 

Therefore, the maximum possible volume, taking into account all the rules and parameters, will be equal to 1 / 3.33 = 0.3 lot

What is a Pipette/Point?

What is 1 point or pipette and how are they different from a pip? 

On exchange markets — stock, futures, etc. — points are the price values ​​before the decimal point. 

For example, if the price of AMZN shares rose from 3284.7 to 3305.4 in a day, stock traders say that the price grew by 21 points.

Fractional pip price values ​​(after the decimal point) are not taken into account: 

3305 – 3284 = 21 pips. 

If you trade contracts for difference (CFDs), whose prices are calculated somewhat similarly to exchange instruments, then even on Forex (Foreign exchange) 1 point will have the same meaning for you. 

A currency pairs point can indicate not only the minimum possible price movement, but also a specific amount of price change equal to 0.00001. Some Forex pairs traders differentiate between the concepts of a pip and a point. 

Since previously, most Forex (foreign exchange) brokers provided only 2 decimal places (example – USDJPY) and 4-digit (example – EURUSD) quotes, the minimum price movements were 0.01 and 0.0001, respectively. This is what was referred to as a pip. 

Pay attention to the screenshot of a 4-digit quote from the MetaTrader terminal.

In time calculations of price changes became more nuanced with the help of 3-digit (USDJPY) and 5-digit (EURUSD) quotes. So the minimum price change for the USD/JPY became 0.001, and for the EUR/USD – 0.00001. 

Therefore, for old school traders the value of 1 pip is still a price change of 0.01 or 0.0001, and more accurate changes of 0.001 and 0.00001 were called a point or a beautiful word “pipette”. 

Therefore, if the exchange rate of the currency pair increased from 1.20251 to 1.20274, then the growth was 2 pips or 23 points:

1.20274 – 1.20251 = 0.00023 

So, using the example of some instrument measured in US dollars, 

Exchange: $1 = 1 point

Forex (foreign exchange) market: a pip is equal to a point and is $0.00001 or $0.0001 with a 4-digit quote.

Cost of one point on Forex

If you are a stock trader, the value of a point for you will be equivalent to the measurement unit of the value of the traded instrument. 

If the instrument is traded in US dollars, then 1 point will be equivalent to $1. If it’s in euros, then 1 euro. 

For Forex traders, 1 point is the same as 1 pip, so it will be calculated in the same way.

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