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What is a Pip in Forex? A Beginner’s Guide to Currency Value Changes

fundyourfx explains what is a pip in forex

Introduction

For a new trader, the first thing that seems unusual while using a trading platform for the first time is calculating pip values and translating them into dollars. The smallest price change that can take place to the left of the decimal point is one pip. In forex, 1 pip always represents the monetary equivalent, and the trader always converts points into dollars when estimating possible profit or loss. Overall, learning how to count pips on the Forex market is essential if you want to determine how much to trade and what potential profits there are given your account balance.

What is a Pip in Forex?

Pips, short for Percentage in Point, are used by forex traders to measure the smallest change in value between two currencies. In a typical forex quote, a pip is represented by a one-digit change in the fourth decimal place. For instance, if the price of EUR/USD moves from 1.2304 to 1.2305, it indicates a one-pip or “point” movement.

Pips and its Profitability

 Three elements that traders need to be aware of to calculate pip value

Traders must keep in mind that forex trading gains and losses are measured in pips. To calculate pip value, traders need to be aware of three elements: the currency pair being traded, the trade quantity, and the current value. Based on these elements, a change of even one pip can considerably affect the open position’s value.

The pip value will be calculated for you by your brokerage. Still, it is important to fully comprehend how pips operate and how to track their swings on a currency chart because it might impact your overall performance.

Determining Pip Value

Forex traders can assign a monetary value to their profit targets and stop loss levels using the calculation of a single pip. Instead of focusing solely on pip movements, traders can predict how the value of their trading account (equity) will change as the forex market moves. The pip value depends on the base currency of the trader’s account.

It’s important to note that the value of one pip can differ for various currency pairs. This is because the value of one pip is always expressed in the quote or variable currency, which fluctuates when trading different currency pairs.

For example, let’s consider a trade with $10,000 on the USD/CAD pair that closed at 1.0568 after a 20-pip increase. To calculate the profit in US dollars, we need to determine the number of Canadian dollars (CAD) each pip represents. Divide the trade’s value by one pip: 10,000 x 0.0001 = 1 CAD per pip.

Pip Value Conversions

The value of one pip can vary between currency pairs due to exchange rate fluctuations. However, there is an interesting exception when the US dollar is the quote currency. Regardless of the specific currency being traded, one pip is always worth US$10 for a standard trade size of 100,000 units.

This standardized pip value of US$10 for 100,000 units makes it easier for forex traders to calculate potential profits or losses. Traders can quickly estimate their earnings or losses by multiplying the number of pips gained or lost by $10.

It’s important to note that this standard pip value may not apply to smaller or larger trade sizes. For mini or micro lots, the pip value would be adjusted accordingly. However, for the standard 100,000-unit trade, the pip value remains consistent at US$10. This serves as a helpful reference point for traders to evaluate their trading performance.

Suppose your trading account is denominated in Canadian Dollars (CAD) and you want to convert the standardized pip value of US$10 into CAD. Considering the exchange rate of 1 USD = 1.34 CAD, we can calculate the equivalent value of one pip in CAD.

Pip value in CAD = Pip value in USD / USD/CAD exchange rate
Pip value in CAD = US$10 / 1.34 CAD/USD
Pip value in CAD ≈ CAD$7.46

So, for a standard lot size of 100,000 units and an exchange rate of 1 USD = 1.34 CAD, each pip represents a value of approximately CAD$7.46. This means that for every pip gained or lost in your trade, your account balance in CAD will increase or decrease by approximately CAD$7.46.

This adjusted pip value in CAD allows traders with CAD-denominated accounts to assess their profits or losses more accurately based on their trading performance in the forex market.

How to Calculate Pip Value

The pip typically equals 0.0001 since it is the lowest unit used to gauge the spread between the bid and ask prices on a foreign currency quote. To compute the value of one pip, divide it in decimal form (here 0.0001) by the current exchange rate – the closing rate after the 2-pip increase. The theoretical amount of the trade must then be multiplied by the outcome.

The pip value will include the exchange rate if the USD is the base currency or the first number in the pair, as in the case of USD/CAD. In this situation, you must multiply your trade value by the pip size and divide the pip size by that exchange rate.

Assume the trader puts a $10,000 long bet on USD/CAD at 1.0570. The USD/CAD exchange rate drops to 1.0540. Here is a breakdown:

1 pip = 0.0001

then, the trader made a loss of 30 pips.

1.0570 – 1.0540 = 0.0030 = 30 pips.

The pip value in USD is (0.0001 x 10,000) / 1.0540 = $0.94

30 x $0.94 = $28.20

Conclusion

Pips are essential for forex traders to calculate profits or losses accurately. They represent the smallest change in currency value and are typically measured in the fourth decimal place of a forex quote.

When the US dollar is the quote currency, one pip is always worth US$10 for a standard trade size of 100,000 units. This standardization simplifies profit assessment.

To calculate pip value, divide the pip size by the exchange rate. For example, if USD/GBP has an exchange rate of 1 USD = 0.8 GBP and the pip value in USD is $10, the equivalent pip value in GBP would be £12.50.

Understanding pips and their value helps traders manage risk and make informed decisions in the forex market. It’s important to consider factors like currency pairs, exchange rates, trade value, and leverage when evaluating potential outcomes.

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