What is a PIP in Forex?
April 28, 2014 by Adam posted in • No Comments
What does Pip Stand for?
PIP in forex is an acronym for Percentage Interest Point, and this represents the smallest price change in the exchange rate of a currency pair.
Most major currency pairs are usually priced to four decimal places (0.0001) on retail forex trading platforms, and this change in the exchange rate is therefore reflected in the last decimal point. These days, we are starting to see platforms with 5 decimal places (and 3 decimal places for the Yen crosses).
These are known as fractional pips and represent one-tenth of the regular pip.
How to Determine the Value of a Pip
The relevance of the pip in forex trading is to know what the movement of a currency pair in pips equates to in monetary terms.
In other words, the value of a pip in the currency trade will be used to calculate what the eventual profits or losses in a trade will be.
Three factors can be used to determine the pip value:
a) Currency Pair
b) Trade Volume/Lot size
c) The price of the currency pair (the exchange rate)
The pip value calculator shown above incorporates these three factors, using just the ask price component of the exchange rate since the value of the base currency is equal to 1.
To appreciate the importance of the fluctuation of currency prices in pips and the monetary implication of such fluctuations, let us consider the example of a trader called Steve who sets a $600,000 trade involving the USDCHF pair.
The trade closed at closed at 1.0370 after gaining 40 pips.
The pip value will determine how much the 40 pips profit will be in US Dollars and to calculate this, we do the following:
a) Determine how many Swiss Francs are represented in each pip represents by multiplying the trade size by the decimal value of 1 pip, which is 600,000 x 0.0001 = 60 CHF per pip.
b) Divide the number of Swiss Francs per pip by the closing price to get the number of USD per pip, which is 60 ÷ 1.0370 = 57.8592USD per pip.
c) Multiply the gain in pips (i.e.
40 pips), by the value of each pip in USD to get the total profit for the trade, which is 40 x 57.8592 = $US2314.368
Now let us confirm this using the pip value calculator:
We can see that the pip value in USD is the same as we got in step B of our manual calculation.
Factors that Affect the Pip Value
There are other aspects of the pip which the trader must know about, and they are highlighted below.
a) Leverage and Pip Value
The forex market is a highly leveraged market.
That is the only way traders can control positions in hundreds of thousands of dollars as well as millions of dollars with a small amount of money.
However, leverage can radically affect the outcome of trades because the full brunt of any losses are borne by the account, just as the full gains of any profits are enjoyed by the trader.
The more leverage used, the riskier your trade position.
To understand the impact of leverage, let us use this example.
A standard lot has a pip value is $10. A $10,000 account used with a leverage of 200:1, means the trader has $2 million ($10,000 x 200) to trade with, or the equivalent of 20 lots ($2,000,000/$10,000).
Extremely risky is an understatement to describe a situation where a trader tries to use the entire $2 million available.
The reason is simple. At $200 a pip (i.e.
Foundations of Technical Analysis: A Step-by-Step Trade Walk-through
pip value of 20 lots), it would only take a loss of 50 pips ($10,000/200) to clean out the account. If a leverage of 50:1 or 400:1 is used, then the trader can either gain/lose $50 per pip or $400/pip.
Tweaking the leverage will therefore impact the pip value, which will also impact the trade outcome.
b) Currency Pair and Pip Value
The pip value in Yen crosses is much different than in other currency pairs.
If the currency you are trading involves the Japanese Yen, the value of the pip would not be 0.0001 but 0.01. Since the JPY is always a base currency, this value (0.01) would have to be divided by the ask price to get the pip value of the currency pair.
For the CHF/JPY currency pair which ends at 115.99 for a 60-pip gain when traded with 500,000 Swiss Francs, the calculation of the pip value is as follows:
- The amount of Japanese Yen per pip is: 500,000 × 0.01 = 5,000
- Pip Value in Swiss Francs: 5,000 ÷ 115.99 = 43.11 CHF per pip
- Trade Profit: 60 pips × 43.11 = 2,586.6 CHF
For the USD/JPY currency pair which ends at 102.66 for a loss of 27 pips, traded with a long order of 200,000 USD, the calculation is as follows:
- The amount of Japanese Yen per pip is: 200,000 × 0.01 = 2,000
- Pip Value in USD: 2,000 ÷ 102.66 = 19.48 USD per pip
- Loss is -27 X 102.66 = $US -2771.82
Traders can access pip value calculators for free on the internet.
It however pays to understand how the pip