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A Pip
Primer
As a
forex trader, your world revolves around pips. That’s
the way it’s been, it is and always will be. It’s
a very small word yet it literally makes the forex trading market
go round. That, then, brings you to the question: what is
a pip?
The word
‘pip’ is an abbreviation for ‘percentage
in point,’ which refers to the smallest movement that
a price could make in the forex trading market. It’s often
the last decimal place when you look at the price of a typical
forex quote. You’ll notice that, for most currencies around
the world, a pip is 0.0001. There are some exceptions, though.
Japanese Yen (JPY), for example, has just two decimal places,
so currency pair with JPY as the quote currency would have a
pip equal to 0.01.
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Undoubtedly,
pips have infinitesimal values – almost nothing, at first
glance. But take into consideration that you’ll most likely
be trading currencies in the tens or even hundreds of thousands,
thus multiplying your pips. Then you begin to see how pips became
the basis for determining your profits or losses when doing
forex trading.
Pip values
fluctuate along with the exchange rates, so they’re rarely
exactly the same. The only exception would be when you have
USD as your quote currency, in which case one pip is equal to
one pip. With USD as quote currency, one pip would equal 0.01
if you have JPY as your base currency, or 0.0001 if you have
just about any other currency as base.
To get the
value of a pip in a currency pair that has USD as a base currency,
you simply divide one pip by the prevailing exchange rate. If,
for example, you have USD/EUR at 1.4285, one pip would be 0.0001
divided by 1.4285, which is equal to about 0.00007. Don’t
be discouraged by the tiny value. Keep in mind that you’ll
be trading thousands of dollars at a time, and that greatly
increases the magnitude of your profits.
You can
thus calculate just how much you make when there’s a price
change in pips. You multiply the pip value by the amount
of money you’re going to invest, and you’re going
to end up with the profit that you make per pip. Using $1,000
for the example above, you would be making about $0.07 per pip
change in price. It’s not too bad a number, when you think
about it.
Pips, although
very small individually, show that there is strength in numbers.
Once you get to multiplying those tiny pip values by the moderate
price changes in the forex market and the thousands of dollars
you’re likely to leverage, you’ll see the huge profit
potential of forex trading.
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