In the forex market convention, a pip represents the smallest whole unit price move that an exchange rate can make. A pip is one-hundredth of 1% (1/100 × 0.01) which is represented in the fourth (0.0001) decimal place. A pip is a fundamental concept of foreign exchange (forex). Forex traders buy and sell a currency whose value is expressed with another currency.
Quotes for these forex pairs appear as bid and ask spreads that are accurate to four decimal places. Pips measure movement in the exchange rate. Since most currency pairs are quoted to a maximum of four decimal places, the smallest whole unit change for these pairs is one pip.
Most currency pairs tend to be priced out to four decimal places, and one pip is a fourth decimal (1/10,000th). In essence, in the case of the USD/CAD currency pair, the smallest whole unit move you can make is one pip ($0.0001). Pips, common in forex trading, differ from bps (basis points), used in interest rate markets, where 1 bps represents 1/100th (0.01%) of 1%.
In this article, we will talk about what are forex pips and how traders use pips? in detail. So, let’s get started!
How do Traders Use Pips?
Okay, so how do traders use pips? Let’s make it practical. Pips are basically how you measure the change in a currency pair’s price, and most importantly, they show you how much money you’ve made or lost on a trade?
Think of the quoted exchange rate as the price tag for one currency in terms of another. Pips are built into that price tag. They represent price changes and are a fundamental part of measuring the value of any price movement.
Here’s a simple example, Let’s say you buy a currency pair for 1.1356, Later, you sell it at a higher cost of 1.1360. See the difference? The price went up by four pips (from 1.1356 to 1.1360). That means you made a profit of four pips on your trade.
To figure out how much money those four pips are actually worth in dollars or whatever your currency is, you need to do a little more math. You have to know the “value of a single pip” for that particular currency pair and how much of it you traded. Once you’ve got those, you can figure out your gain from the position you took in the market. But the first step is always figuring out the pip change!
Calculating Pip Value
A pip’s value varies on the currency pair, the exchange rate, and the trade value. When your forex account is funded with U.S. dollars, and USD is the second of the pair or the quote currency, such as with the EUR/USD pair, the pip is fixed at 0.0001. Okay, let’s make calculating the dollar value of pips super simple, using that easy case we just talked about:
Since we know the pip value is fixed at $0.0001, when your account is in USD and USD is the quote currency, figuring out the dollar value is just one step. Multiply your trade size by 0.0001. That’s it! For example, if You trade 10,000 euros in the EUR/USD pair and multiply 10,000 by 0.0001, the result is $1. This means each pip is worth $1 for this specific trade size.
Now, let’s see how that works in a real trade example. You buy 10,000 euros (EUR/USD) at 1.0801, if you sell them later at 1.0811, and then the price moves up by 10 pips (1.0801 to 1.0811). Since each pip is worth $1 (for this trade size), you made a profit of 10 pips $1/pip = $10.
| Equation | Value |
| Value Traded × Quote Currency Pip = Pip Value | 10,000 × 0.0001 = 1 |
So, the key is to find the pip change, then multiply it by the pip value (which is often $0.0001 times your trade size when dealing with USD as the quote currency). This shows the gain (or loss) on your position.
If the USD is the first of the pair or the base currency, like the USD/CAD pair, the pip value also involves the exchange rate. Divide the size of a pip by the exchange rate and then multiply by the trade value or lot size.
- Trade Value (Pip Size ÷ Exchange Rate) = Pip Value
- 100,000 (0.0001 ÷ 1.2829) = 7.7948
For example, 0.0001 divided by a USD/CAD exchange rate of 1.2829 and multiplied by a standard lot size of 100,000 results in a pip value of $7.79. If you bought 100,000 USD against the Canadian dollar at 1.2829 and sold at 1.2830, you’d make a profit of 1 pip or $7.79.
Pips and Profitability
The movement of the exchange rate of a currency pair explains whether a trader makes a profit or loss at the end of the day. A trader who buys the EUR/USD will profit if the euro increases in value relative to the U.S. dollar. If the trader bought the euro for 1.1835 and exited the trade at 1.1901, they would make 66 pips on the trade (1.1901 – 1.1835).
Now, consider a trader who buys the Japanese yen by selling the USD/JPY pair at 112.06. The trader will lose three pips on the trade if they close out the position at 112.09. They profit by five pips if they close it out at 112.01.
While the difference may look small, in the multitrillion-dollar foreign exchange market, gains and losses can add up quickly. For example, on a $10 million position that closed at 112.01, the trader would make ¥500,000. In U.S. dollars, that’s $4,463.89 (¥500,000 / 112.01).
Practical Example of Pip
When a country experiences both hyperinflation and currency devaluation, its exchange rate can spiral out of control. This not only affects everyday people who may need to carry huge amounts of cash just to buy basic goods but also makes currency trading nearly impossible. At that point, the idea of a pip (the smallest price movement in forex trading) becomes meaningless.
A famous example is Germany’s Weimar Republic in the early 1920s. Before World War I, one U.S. dollar was worth 4.2 German marks. By November 1923, that same dollar was worth a staggering 4.2 trillion marks.
Another case is the Turkish lira. By 2001, its value had plummeted to 1.6 million per U.S. dollar so high that many trading systems couldn’t even process the numbers. To fix this, the government removed six zeros from the currency and introduced the “new” Turkish lira. As of February 2024, the exchange rate stood at about 0.032 lire per U.S. dollar (TKY/USD).
What is the difference between Pips and Pipettes?
In the foreign exchange (forex) market, a pip is the standard way to measure changes in currency prices. For most currency pairs, one pip equals 0.0001 (or 1/10,000). This is the smallest price movement that traders usually track.
- A pipette is even smaller it’s 1/10 of a pip, or 0.00001 (1/100,000).
Simply put, a pip represents a change in the fourth decimal place of an exchange rate, while a pipette measures movement in the fifth decimal place.
Frequently Asked Questions (FAQ’s)
Question: What is a pip in forex trading?
A pip (short for “percentage in point“) is the smallest price movement in most currency pairs. For most pairs, one pip equals 0.0001 (or 1/10,000) of the quoted price.
Question: Why are pips important in forex trading?
Pips help traders measure price changes, calculate profits and losses, and set stop-loss or take-profit levels. They provide a standard way to track market movements.
Question: How do traders use pips to calculate profit and loss?
Traders multiply the number of pips gained or lost by the lot size (trade volume) and the pip value per lot. The pip value depends on the currency pair and trade size.
Question: Do all currency pairs follow the same pip measurement?
No. Most currency pairs use four decimal places (0.0001 per pip), but some, like USD/JPY, use two decimal places (0.01 per pip).
Question: How do traders manage risk using pips?
Traders set stop-loss and take-profit orders based on pip movements. This helps limit potential losses and secure profits in volatile markets.
Question: Are pips relevant for all types of traders?
Yes. Whether you’re a day trader, swing trader, or long-term investor, understanding pips is crucial for tracking market movements and making informed trades.
Conclusion
In forex trading, pips are the basic unit for measuring price changes in currency pairs. They help traders track market movements and calculate profits or losses. By understanding pips, traders can set stop-loss and take-profit levels, manage risk, and make informed decisions. Whether trading major, minor, or exotic pairs, knowing how pips work is essential for navigating the forex market successfully. In this article, we’ve discussed what are forex pips and how traders use pips in brief. Follow us to know more, FX-Guide Pro is here to tell you all about trading. Trade like a pro!
