If you are interested in making money in FOREX, you must know one of the fundamental concepts of this market, the PIPs. Continue reading this brief guide to learn how to quantify your profits and losses.
What are PIPs?
PIP is an acronym for “Percentage in Point” and generally refers to the minimum movement an exchange rate can experience. Most currency pairs are quoted to four or five decimal places, and a PIP is the last decimal place in the quote. For example, if the EUR/USD moves from 1.3000 to 1.3001, this means a change of 1 PIP.
Role of PIPs in Forex Trading
PIPs play a crucial role in Forex trading. They are the basis for calculating profit and loss, determining the profitability of a trade. Traders use the movement of PIPs to measure market volatility and establish risk management strategies.
How much is a pip worth in trading?
The value of a pip in trading can vary depending on the size of the position and the currency pair traded. If quoted to 4 decimal places as is normal the value of the PIP is 0.0001; for pairs with the Japanese Yen, the value of the PIP would be 0.01.
The calculation of a pip value is determined by multiplying the position size by the pip value of the currency pair. For example, if you are trading a standard lot (100,000 units) on EUR/USD, where one pip is 0.0001 and the position size is 100,000, the value per pip would be 10 units of the quoted currency (USD). However, for the calculation of profit and loss the PIP value is expressed in terms of the base currency, as follows
Monetary value of the PIP
The monetary value is expressed in terms of the base currency and serves as a reference to know how much you gain or lose from a change in the quote price. It is calculated as follows:
PIP expressed in base currency = [pip value * (1/quote price)] * Volume.
For a micro lot of EUR/USD 1.2540 the monetary value of 1 PIP is:
P-value = 0.0001
PIP expressed in base currency = [0.0001 * ( 1/ 1.2540)] * 10,000
PIP expressed in the base currency = 0.89 EUR
So, your profit or loss will be determined by each PIP that goes up or down in the price.
If the price rises to 1.2560 you will have increased 20 PIPs, therefore you will have gained (20 * 0.89 = 17.8 EUR).
If the price goes down to 1,2520 you will have lost 20 PIPs, therefore you will have lost ( 20 * 0,89 = 17,8 EUR)
How They Are Used to Calculate Profits and Losses
Forex profit and loss calculations are based on the movement of PIPs. Let’s consider an example of how PIPs are applied in determining profit and loss:
Profit Example: suppose you decide to buy GBP/USD at 1.3500 and subsequently the price rises to 1.3550 when you close the trade. The difference is 50 PIPs. If your position size is a standard lot (100,000 units), the profit would be 50 PIPs.
that is a profit of 370.74 EUR following the above formula.
Loss Example: On the other hand, if you open a trade on USD/JPY at 110.50 and the price drops to 110.00 when you close the position, you have lost 50 PIPs. If your position size is one standard lot, the loss would be 50 PIPs * 100000 units of the quoted currency (JPY) per lot = 452 USD loss following the formula in the previous section.
Exceptions to the Pip Rule
In the case of the Japanese yen (JPY), the quote of a pip is different because it is expressed to two decimal places instead of four like most currency pairs. Therefore, one pip in the USD/JPY is calculated as 0.01 instead of 0.0001. This means that a one pip movement in the USD/JPY is reflected as a 0.01 change in the exchange rate, which directly affects the monetary value of the pip in this pair.
What is a Pipette in Forex Trading?
A pipette, also known as a “fraction of a pip”, is a smaller unit of measurement than a standard pip and is used to reflect even smaller changes in the prices of currency pairs. A pipette is equal to 1/10 of a pip and is represented by an additional decimal place in price quotes. For example, if the EUR/USD moves from 1.25000 to 1.25010, it has moved up 1 pipette. The use of pipettes allows for greater accuracy in tracking minute movements in Forex market prices.
What is the monetary effect of a pip movement in trading?
The monetary effect of a pip movement in trading refers to the impact that a one pip movement has on the monetary value of a currency trade. It is essential to understand this effect in order to assess the potential for profit or loss on a specific trade.
The value of a pip varies depending on the currency pair and the size of the position. For example, in a pair such as EUR/USD, where the value of one pip for a standard lot may be 10 units of the quoted currency (usually dollars), a change of one pip will result in a gain or loss of 10 units of the quoted currency per lot.
Suppose you are trading EUR/USD with one standard lot and the price moves in your favor by 50 pips. If the value of a pip for this pair is $10, then:
Profit = PIP monetary value x Number of PIPS.
In this hypothetical scenario, a 50 pip move in the EUR/USD would result in a profit of $500 if the trade goes in your direction. On the other hand, if the market moves against you, a 50 pip move would result in a $500 loss.
Understanding the currency effect of PIP movements is crucial to assessing the risk and potential profitability of a trade in the foreign exchange market, allowing traders to properly manage their positions and make informed decisions.