What is a Pip in Forex trading? Definition and examples
Knowledge of terminology is one of the most important factors of success in trading in financial markets. A trader needs to be on the same page with other traders and analysts, understand the information given in training materials and special literature, reviews, and market forecasts.
The list of the most basic concepts of trading includes "point" and "pips". They are related to current asset prices and quotes and are the key to calculating all values - changes in a financial instrument's value, profits, and losses on open positions and completed trades, movement targets, and stop levels.
Today we will learn what are pips in forex trading, how to calculate pip value, as well as what is the cost of one point in forex.
Pips Definition & Meaning
To make it easier to understand what pips and points are and how they differ, let's give a simplified definition that all beginners will understand:
- 1 pip is the smallest available price change of 1 decimal point (0.0001) for four-digit quotes and 1 hundredth (0.01) for two-digit quotes.
- 1 pip is the smallest available price change of 1 hundred thousandths (0.00001) for five-digit quotes and 1 thousandth (0.001) for three-digit quotes.
The definition of points and pips implies that one point is 1/10 of a pip.
In other words, if you have four-digit (or two-digit) quotes, your minimum tick equals one point. If you have five- or three-digit quotes - the minimal tick is one point. In this case, the minimum tick is understood as the minimum distance that the price can pass.
For four- and two-digit quotes (pairs containing Japanese Yen) 1 pip will be equal to 0,0001 and 0,01 correspondingly, that is - the fourth or the second decimal place. However, if we are talking about five- and three-digit quotes, then the minimum step of price change will be 0.00001 and 0.001 (the fifth and third decimal place), and it is called a 1 pip, while 1 pip will be equal to 10 points.
Different brokers offer different quotes. If at the broker with the four-digit quotes the price of the currency instrument will look like 1.2255 for example, then at the broker with the five-digit quotes it will look like 1.22555 (or any other figure in the end). It is possible to conclude that pip is a more exact unit of price measurement than a point.
Who and why would want to measure the price in points? It is logical to suppose that the points were the first to appear. When the forex market was at the beginning of its development, the trades were made by phone and not so often as now - technologies could not provide fast and constant access to the trades. And because of that, traders did not need the most accurate quotes.
With the appearance of the Internet, brokers began to offer an improved service, streaming quotes continuously, almost in real-time. These innovations made it possible to technically organize faster execution of transactions, which resulted in the emergence of new market participants who prefer short-term transactions. They are day traders and scalpers. On the background of traders' activity, the liquidity has increased, and spreads became narrower, which was difficult to measure in points. Nowadays, it is not uncommon to hear about spreads from 0.3 points to 1.6. As a result, there is a need for more accurate quotes.
But even after the appearance of the fifth (third) digit after the decimal point, traders called it a pip and got confused with quotes. That is why the notion of 1 pip was introduced - the last digit in such a quote. But habit is a thing that cannot be easily broken. That is why very often many traders still use the concept of a point for all quotes or equate a point with a pip. Though, as we have found out, 1 pip always consists of 10 points.
The situation on stock markets is quite different. The minimal unit of measure of the price at them is 1 cent, also known as a pip. Do you know what 1 pip equals on the stock exchange? It is equal to 100 cents, or 100 pips. That is, the value of a pip on the stock exchange will be $1.
The term pips appeared in the financial markets for several reasons:
- To simplify the presentation and understanding of analyses and forecasts. For example, if the euro/dollar pair quotes change by one unit, the expression "growth (fall) of the price is 1 pip" is easier and more understandable than "growth (fall) of the price is one ten-thousandth of a dollar per euro";
- We use pips to compare different instruments, strategies, and trading systems to increase efficiency. Pip is a relative value and allows the comparison of magnitudes, which are different times. For example, a change of 100 pips in quotes or a 100 pips profit on EUR/USD and USD/JPY describes the same phenomenon, although they are significantly different in absolute values.
In addition, the use of special terms allows us to talk about different markets and assets in the same way. For example, on the American stock exchange stock quotes are tied to the U.S. dollar, in the forex market the value of the base currency is expressed through the quoted one, and on the bond market it is customary to operate with values expressed in percentages. At the same time, analytical information and strategies using the same terminology (points and pips) are available for parsing and use by any specialist (trader).
Calculating Pip value
At the foreign exchange market, 1 pip always corresponds to a money equivalent, and when calculating a potential profit or loss, a trader also always converts pips to dollars. It can be done independently or with the help of special instruments in automatic mode. For direct quotes, i.e., where the US dollar is in the first place in a pair, the pip value will be calculated by this formula: lot volume * pip size / current quote. If you open a buy position with a volume of 0.1 lot (10,000 of the base currency) on the USD/CHF pair with the current rate of 0.9951, the pip will equal 1 dollar (10,000 * 0.0001/0.9951 = 1.0049 dollars, rounded to 1). If the price of the currency instrument increases by 50 pips in forex trading, the trader will earn $50, and if the position is closed with a Stop-Loss set at 30 pips, then his loss will be $30.
The calculation of the pip value is slightly different for pairs with indirect quotes (where the dollar is in the second place) or cross rates (where there is no dollar). For indirect quotes, 1 pip in a 0.1 lot position will always be equal to $1, regardless of the current rate; the pip value calculation formula will look as follows: pip value * position volume. This is exactly how the pip value is calculated for the most popular currency pair - EUR/USD.
To calculate the pip value in cross rates because the formula is not very simple and looks like this: pip value * position volume * the current price of the base currency against the U.S. dollar / current rate of the currency pair (cross-rate), especially useful will be the forex calculator, about which we will talk a little later. So, if you place an order with 0.1 lot on GBP/CHF pair with the current price of 1.3015, 1 pip will equal 10 000*0.0001*1.3081 (the current GBP/USD rate)/1.3015 = 1.0051, which is rounded up to 1.
We remember how many points there are in one pip - 10, so, if necessary, we can calculate the value of one point by dividing the pip price by 10.
To avoid having to calculate in your mind (or on a piece of paper) the value of a potential profit or loss each time you open a trade, we recommend that beginners use the online pip value calculator.
To use the calculator, you need to enter the initial position data:
- Specify the currency of your account.
- Select the instrument in which you are going to invest. Detailed investment conditions for each asset are presented in the table "Contract Specifications".
- Specify the number of lots you are going to trade.
- Specify the leverage you intend to invest in.
Why do we need such a calculation? Because every trader must have a trading plan, which also necessarily considers the potential profit or loss. Often the parameters are expressed in the account currency, but a trader gets his profit in pips and only then converts it to currency.
All these calculations should not scare newbies because they are successfully performed automatically by the broker: a trader can see the current profit and loss directly in the terminal when placing an order. But keep in mind that only the current figures are available - there are no calculations of possible profits/losses of the trade in the terminal!
Finding Pip value in the trading account
It should be noted that knowledge of all the above-mentioned formulas for the trader is not required, since in the MT4 terminal the price of one point is calculated immediately after the opening of a trading order and the size of the resulting profit or loss is displayed directly in the chart.
Let us examine this situation in the example of the EUR/USD currency pair. For this purpose, opening the New Order window for the above-mentioned currency pair EUR/USD, in the drop-down list set the lot size equal to 1.
Then we buy the Euro at 1.1735, determining a price change of 10 points. Take-Profit is set at 1.1745. Given that one pip for this currency pair costs $10, then the profit will be $100.
If the trader decides to close the position at 1.1835, having bought one lot at the price of 1.1735 and having decided that the market will rise higher by one hundred pips, his profit will be ten times more, i.e. $1,000.
After the order is closed, an automatic fixation of profit and its recalculation into the deposit currency takes place.
Base and quote currency explained
Now the question "What are pips in forex trading?" has been answered in detail, we would like to conclude by explaining two other terms that have been mentioned repeatedly throughout the article and are inseparable from forex trading. These are the terms base currency and quote currency. The distinction is important so that investors actually know in which currency they are selling and which currency they are buying.
As should be known by now, the foreign exchange market is always quoted as currency pairs. EUR/USD, GBP/USD, or USD/CHF are just a few of numerous examples. The first currency mentioned in this quote is called the base currency. It is the currency that is bought. The second currency is the quote currency and therefore the currency in which the payment is made.
Thus, when opening a long position in the EUR/USD currency pair, the purchase is made in Euros, and the payment is made in US dollars. If the rate is 1.2518, this is the purchase price for one euro in dollars.
Major currencies pips
Major forex pairs or majors are currency pairs consisting of the major and most liquid currencies, which include USD, EUR, JPY, CHF, GBP. Some include NZD, AUD, CAD, although their liquidity is inferior to the major ones.
Why are many traders interested in major currency pairs? Due to high liquidity, instruments involving major currencies have lower spreads and slippage, and consequently, they execute trades more quickly. It is easier to trade on major currency pairs. The lion's share of the market is occupied by currency pairs with the American dollar in their quotes. Basically, the pairs traded with the dollar cover more than 80% of the forex market.
Major currency pairs include:
- EUR / USD: Euro / US Dollar
- USD/JPY: US dollar/Japanese Yen
- GBP / USD: British Pound / US Dollar
- USD / CHF: US Dollar / Swiss Franc
- USD / CAD: US Dollar / Canadian Dollar
- AUD / USD: Australian Dollar / US Dollar
- NZD / USD: New Zealand Dollar / US Dollar
EUR/USD is characterized by relatively smooth movements without volatility bursts, while the pair is always active and is considered as an excellent trading instrument not only for experienced traders but also for those who are just mastering the Forex market. A lot of forex statistics and analytical studies, as well as numerous publications, allow making correct forecasts within a day and for a long distance.
The USD/JPY currency pair, like all forex major pairs, has a small spread. It is actively traded during the whole day, but especially during the Asian session. It moves smoothly, but it reacts sharply to emerging financial risks and news on the dollar. As a rule, the yen goes up (the pair's chart goes down), as investors start closing trades with the carry trade.
GBP/USD is the third most traded currency pair. Although the UK has been a part of the European Union for some time, it did not give up its own currency for economic reasons, although the historical value of the pound probably played its role as well. The pound can be called one of the world's reserve currencies, analysts pay a lot of attention to it, and traders show considerable interest.
For the US dollar, euro, British pound, or Swiss franc, 1 pip is 0.0001. For USD/CHF quotes, 1 pip would be equal to 0.0001 CHF. Most currencies are traded in the range of 100 to 150 pips per day.
The special position of the Japanese yen among the major currencies has already been mentioned several times. Even beginners who have only recently started to deal with the question "What is forex?" will quickly realize that the value of a single pip is many times higher compared to many other currencies. The reason for this can be found in the very low value of the yen against the US dollar. Nevertheless, USD/JPY is one of the four most popular currency pairs, along with EUR/USD, GBP/USD, and USD/CHF.
In a way, the yen is seen as a "safe-haven" in economically turbulent times. Low growth in the country is countered with low-interest rates, for example. It can be quite attractive for traders to borrow money in a country with low-interest rates and invest it in a country where higher interest rates prevail.
Since one pip in the USD/JPY forex pair is only 0.01, which is a hundred times higher than any other major currency, the forex pip value of a lot is also equal to 1,000 JPY.
Pips and price movement
The calculation of the value of a trader`s potential profit or potential loss is of great importance for the trader's trading analysis.
In fact, the calculation of forex profit is made automatically in any trading terminal, but sometimes it is necessary to predict the profit, considering the leverage and the amount of the initial deposit.
You always want to know how much profit you will get when the exchange rate changes by 1 pip. The calculation itself is straightforward, but it requires some background data.
Forex profit is a financial result from operations on the foreign exchange market, it can be calculated as from one individual operation, as well as over a certain period, depending on the objectives pursued by the trader.
The first thing to know is what volume of currency is included in one Forex lot or part of it - 0.1 or 0.01 - only on cent accounts.
Forex lot is equal to 100,000 units of the base currency, for example, on the currency pair Euro / US Dollar one lot will be equal to 100,000 euros, 0.1 - 10 000, 0.01 - 1 000.
The second thing to figure out is the value of the point. This calculation is carried out as follows;
The cost of one pip = step of the quote x trade volume
Once we have figured out the basic concepts, we can proceed directly to the calculation of the financial result.
We have 10 US dollars, the leverage of 1:500, the currency pair EUR / USD, for which we can buy a maximum of 0.03 lots.
Now let's find out the value of a forex point in our case.
0.03x100 000 = 3 000 euros - the size of our lot in the base currency
After multiplying the quote step by the volume of the position.
1 pip equals = 0.0001x3000 = $0.3.
As a result, it becomes clear that a change in the rate in the desired direction by 10 points will bring us $3 of income, with an initial deposit of only $10. The main thing is that this movement has obeyed us and has taken place.
Now, we calculate the profit for a certain period. Calculating the profit in forex trading is not difficult, the main thing before you familiarize yourself with the basic concepts, if you are too lazy to work at the calculations, the trading terminal itself will calculate your profit or loss.
To calculate the financial result for a certain period, you will need to subtract all deposits at the end of the analyzed period from the amount of funds and the amount at the beginning of the period, for clarity, let's calculate the profit for the month.
Initial data - the balance at the end - 1750, deposit 500, on the first day of the account was $ 1000. As a result, 1750-500-1000 = 250 profit for the month.
Such a calculation of profit is not difficult, the main thing before starting the calculations, a grouping of all the necessary data.
In most cases, the base currency of your account will determine the value of various currency pairs in pips in forex trading. If your account is denominated in U.S. dollars and the pair includes a U.S. dollar, such as EUR/USD, then the pip value will be fixed as we discussed earlier. In this case, a standard lot would have a 10 pip value, a mini lot would have a $1 value and a micro lot would have a 0.1 pip value.
The point value would only change if the US dollar exchange rate were to change by more than 10%, whereas the US dollar is the base currency in a USD/CAD or USD/JPY pair for example, or the US dollar is not included in a currency pair such as GBP/JPY.
A good example is a case where the USD/JPY exchange rate fell from 120 to a low of about 77 between 2008 and 2011. The rapid strengthening of the yen led to a change in the point value for that currency pair. In this case, market movements had a much greater impact on the value as the point value rose.
Based on what we have learned, let's now see what effect this change had on the point value of the pair. The exchange rate in this case changed from 120 to 77. Before 2008, the point value for standard USD/JPY lots in a USD account was 10/120 * 100 = 8333. By 2011, the exchange rate had risen to 77, and the pip value increased over the period to 10/77 * 100 = 12.98. Thus, market movements had a greater impact on the value.
What is a Pipette?
So, what is a pip in forex trading? This question has been answered in detail up to this point. All the characteristics of a pip have been explained and the differences between major and minor currencies have been explained. This has also resulted in the procedure for calculating the pip value. By the way, investors rarely must calculate this themselves. A modern Forex trading software already provides this function and thus ensures considerable timesaving.
However, one term has not yet been mentioned in this article, although it is also inextricably linked to pips in forex trading: the term pipette. When there are five decimal places in the price display instead of four, the last decimal place is called a pipette. One pipette is equal to one-tenth of a pip. This additional decimal place gives traders the opportunity to profit from even the smallest price changes.
In the case of the Japanese yen, the pipette refers to the third decimal place.
Cost of one point on Forex
If you have a forex trading account at AdroFx and want to trade a currency pair, you will not find only one quoted price. Each underlying asset basically comes with two rates, the value of which differs by a few pips. The first of the two rates represents the buying price for the underlying asset, while the second represents the selling price. In this context, we also speak of bid and ask prices.
The difference between the two prices is the spread. Traders should pay attention to the size of the spread, as it represents the cost that must be paid by the trader when opening a position. Narrow spreads are therefore always attractive, as only a small price movement needs to take place to offset these costs. However, the wider the spreads are, the less favorable this is for investors. Accordingly, pips can be used to represent forex trading costs as well.
However, the spread represents only part of the costs that may be incurred on a trade. Especially in a comparison of different brokers, the other cost items should also be considered to ultimately find the right provider. AdroFx can satisfy this area with a transparent cost model that is oriented towards the needs of the customer.
Nevertheless, the narrowest possible spreads are offered in all underlying in order to keep the trading costs for investors as low as possible. The minimum deposit of $0 also makes the offer attractive for beginners who want to get to know forex trading and rely on the support of the AdroFx team. This way, you can calmly deal with the question "What do pips mean in forex trading?".
The bottom line is that the forex pip is a metric that every trader should know. If you know how to convert a pip into dollars or euros, you will be able to see the possible profits or losses even before opening a position. In addition, the spread is also expressed in pips, which allows you to calculate the trading costs at the same time.
What is a pip in forex trading? As it turns out, the question posed at the beginning can also be answered in a few words. However, on closer inspection, this short term hides a complex topic, which should not be neglected by traders. You can also trade foreign exchange as a CFD at AdroFx. Due to the extensive glossary and the possibility to start with the demo account without risk, AdroFx is optimally suited for beginners.
What are pips in forex trading?
Pip is an acronym for "point in percentage" and represents the smallest unit of change in the value of a currency pair. For most currencies, especially major currencies, the pip represents the fourth decimal place in the exchange rate for two currencies. However, this decimal place may be different for some currency pairs. For currency pairs that include JPY, the point is represented by the second decimal place.
What does the price depend on?
The monetary value of a pip in trading is influenced by:
- The type of currency pair used;
- The volume of a lot (open position);
- Current quotes of the exchange operation.
In this case, the price of the order opened on the forex directly depends on the value and number of pips. Changes to the lesser side lead to a drop in the total value of the asset, while an increase captures the growth.
Why do I need pips in forex trading?
When evaluating in fixed units, it is easier to compare assets of different types. For example, a change in quotes for an asset corresponds to a correction in the rate of the index linked to it. To calculate a trading profit or loss, traders simply calculate
- the value of 1 point;
- the difference between the exchange rates;
- multiplication of the nominal price by the number of points.
How do I calculate the pip and point value in forex?
The calculation of the pip value in money terms is quite simple. Let's take the most popular Forex pair EUR/USD as an example. If a trader is going to buy 100,000 EUR at the rate of 1.1600 USD, he will have to pay 116,000 USD. In this case, the pip is calculated as follows.
Knowing that the value of a pip in trading is 0.0001, multiply it by the volume of the base currency of the deal - 100 000 EUR, and then multiply by the EUR/USD rate 1.1600. Thus, we receive a pip in the basic currency equivalent - 0,8620 EUR.
As for the points, the calculation is carried out by the same formula, the only difference being the difference in values - as opposed to the pips in forex trading, it is 0,001.
If you do not want to calculate pips or points manually, online pips calculators can be used to assist you. Any novice trader can use the calculator on the broker's website. However, one should not start trading in the market without prior experience on a demo account. In such a way, the trader will monitor the dependence of profit on changes in quotes, as well as will learn to calculate the pips value.
We have found out the difference between points and pips, how to calculate their values in money equivalent, how many points are in one pip and also have got acquainted with a tool for simple calculation of points and pips pips in forex trading. From this article, we can conclude that the appearance of pips is the result of the natural development of the markets and technologies. It is possible that in the future traders will need even more precise quotes, and then after the comma, there will appear the 6th digit, which will be called a micropips, for example. Or in some other way - it does not matter for us. At this point, it is important for us to use the correct forex market terminology and not to confuse the fundamental concepts!
Being a well-established brokerage company, AdroFx offers the best trading conditions to its clients from 200 countries. Founded by experts with a couple of decades of the overall experience, AdroFx is one of the best platforms on the market for shares trading. Either a newbie or experienced trader, both will find here what they are looking for since the company provides various trading accounts for different trading styles and goals.