In the world of foreign exchange (forex) trading, a “pip” is a key term you need to know. Pips are used to measure changes in the value of currency pairs. When trading currencies, you buy one currency while selling another, and the exchange rate tells you how much one currency is worth in relation to another.

When you look at forex quotes, you’ll notice they are typically displayed with four decimal places. This precision is important because it helps traders see even small changes in currency values. 

The smallest price movement that can occur in these quotes is called a pip, and for most currency pairs, this is equivalent to a change of 0.0001 in the exchange rate.

In summary, pips are crucial for understanding how currency values fluctuate in the forex market, allowing traders to track their profits and losses effectively. Let’s discuss what is a pip in forex on this article

What Is a Pip?

What is a pip in forex? A pip is the smallest price movement in the forex market, representing one-hundredth of one percent (0.01%). It is typically displayed in the fourth decimal place of a currency pair’s price. For most currency pairs, this means that a pip is equal to 0.0001.

For example, in the USD/CAD currency pair, the smallest price change you can see is $0.0001, which is one pip.

It’s important to note that pips and basis points (bps) are different. While pips are used in currency trading, basis points are used in interest rate markets and equal 1/100th of one percent (0.01%).

Calculating Pip Value

When trading in the forex market, understanding pip values is crucial. The value of a pip can vary depending on the currency pair you are trading, the exchange rate, and the size of your trade.

For instance, if your forex account is in U.S. dollars and the currency pair you’re dealing with has USD as the quote currency (the second currency in the pair), such as with the EUR/USD pair, the pip value is set at 0.0001.

To calculate the value of a pip for this scenario, you simply multiply your trade size by 0.0001. Let’s say you’re trading 10,000 euros. The calculation would look like this:

Trade Value: 10,000 euros

Pip Value Calculation: 10,000 × 0.0001 = $1

So, if you purchased 10,000 euros at an exchange rate of 1.0801 and later sold it at 1.0811, you’ve made a profit of 10 pips, which equals $10.

Now, if USD is the base currency (the first currency in the pair), like in the USD/CAD pair, the pip value calculation changes slightly. Here, you need to consider the exchange rate. You would first divide the pip size by the exchange rate and then multiply that by your trade size.

For example, here’s how to find the pip value for a standard lot of 100,000 USD at an exchange rate of 1.2829:

• Pip Size: 0.0001
• Exchange Rate: 1.2829
• Trade Size: 100,000 USD

The calculation would be:

Pip Value Calculation: (0.0001 ÷ 1.2829) × 100,000 = $7.79

In this case, if you bought 100,000 USD against CAD at 1.2829 and sold it at 1.2830, you’d earn a profit of 1 pip, which amounts to $7.79.

JPY Exception

When trading currency pairs that involve the Japanese yen (JPY), it’s important to note that they are quoted differently than most other pairs. Instead of the usual four decimal places, JPY pairs like EUR/JPY and USD/JPY are quoted with just two decimal places.

To determine the value of a pip for these pairs, you can use the following formula: take 1 divided by 100 and then divide that by the exchange rate. For instance, if the EUR/JPY rate is 132.62, the pip value would be calculated as 1/100 ÷ 132.62, resulting in approximately 0.0000754.

If you’re trading with a standard lot size of 100,000 euros, each pip would be worth about $7.54 in USD. This means understanding pip values is crucial for effective trading in JPY currency pairs.

Pips and Profitability

The exchange rate of currency pairs plays a crucial role in determining whether a trader ends up with a profit or a loss. For example, if a trader buys the EUR/USD pair and the value of the euro goes up against the U.S. dollar, they stand to gain. If they purchased euros at an exchange rate of 1.1835 and sold them later at 1.1901, they would earn 66 pips, calculated as 1.1901 minus 1.1835.

Let’s consider another scenario involving the USD/JPY pair. If a trader sells this pair at 112.06 to buy Japanese yen, they could face losses or gains depending on the closing price. If they close their position at 112.09, they incur a loss of three pips. Conversely, if they close at 112.01, they make a profit of five pips.

Though these differences might seem minor, they can have significant financial implications in the vast foreign exchange market. For instance, on a $10 million position that concludes at 112.01, the trader would gain ¥500,000. When converted back to U.S. dollars, this amounts to approximately $4,463.89 (¥500,000 divided by 112.01).

Examples of Pip

Hyperinflation and currency devaluation can lead to extremely unstable exchange rates, making it difficult for consumers and businesses to manage their finances. When inflation skyrockets, people often find themselves needing to carry large amounts of cash for even the simplest purchases. This situation complicates trading and causes the concept of a pip, a standard unit of measurement in forex trading, to lose its significance.

A notable historical example of this phenomenon occurred in Germany during the Weimar Republic. After World War I, the value of the German mark plummeted from 4.2 marks per dollar to an astonishing 4.2 trillion marks per dollar by November 1923.

Another instance is the Turkish lira, which experienced a dramatic decline in value, reaching 1.6 million lira per dollar in 2001. This devaluation became so extreme that many trading systems were unable to keep up with it. In response, the Turkish government decided to remove six zeros from the exchange rate and introduced a new currency called the new Turkish lira. As of February 2024, the exchange rate stands at approximately 0.032 lira per dollar (TKY/USD).

What Is the Difference Between a Pip and a Pippette?

In the foreign exchange market, a “pip” is a key term that stands for the smallest unit of price movement in currency pairs. Specifically, a pip represents a change of 0.0001, which is equivalent to 1/10,000. This is the minimal amount by which most currency pairs can fluctuate.

On the other hand, there is a smaller unit called a “pipette.” A pipette is 1/10 of a pip, meaning it measures price changes in the fifth decimal place, which corresponds to 0.00001 or 1/100,000.

How Are Pips Used?

Pips, or “percentage in points,” refer to the smallest price change in a currency pair’s exchange rate. They play a crucial role in determining how much your position in the market has changed in value.

For example, if you buy a currency pair at an exchange rate of 1.1356 and later sell it at 1.1360, you’ve gained four pips from that trade. This difference is important because it reflects your profit from the transaction.

To calculate your actual profit, you’ll need to determine the value of a single pip. This value can vary depending on the lot size of your trade, which refers to the amount of currency you are trading. By multiplying the pip value by your lot size, you can find out the dollar amount of your profit.

Does the Japanese Yen Forex Rate Use Pips?

In currency trading, a pip is a standard unit of measurement used to express changes in value between two currencies. For most currency pairs, a pip is typically represented as a movement of 0.0001. However, the Japanese yen is different. In the case of the yen, a pip is defined as 0.01, meaning that it is quoted with two decimal places instead of four. This distinction is important for traders to understand when analyzing exchange rates involving the yen.

What Is the Spread in a Forex?

The forex spread represents the difference between the buy (ask) price and the sell (bid) price of a currency pair. For instance, if the EUR/USD pair has an ask price of 1.1053 and a bid price of 1.1051, the spread would be 0.0002, which equals 2 pips.

To determine the cost of this spread, you multiply the spread by the size of your trade. For example, if you decide to trade 100,000 units of EUR/USD with a 2-pip spread, the cost of the spread would be $20.00. This is calculated as follows: 0.0002 (the spread) multiplied by 100,000 (the volume of the trade).

Conclusion

Understanding what a pip is—and how to calculate its value—is fundamental for anyone entering the forex market. Whether you’re managing risk, measuring profit and loss, or analyzing price movements, mastering pips equips you with the precision needed to trade confidently. As you continue learning and practicing, this small yet powerful unit of measurement will become second nature in your trading journey.