Understanding Pips In Forex Trading

Understanding Pips In The Forex Market

To forex traders, everything revolves around pips.

"I'm up 35 pips for the day."

"I made a 127 pip profit on my last trade."

That's great, but what's a pip?

Pip is short for "percentage in point" and you may sometimes hear people refer to pips as points.

Put simply, a pip is the smallest unit of price for a currency. It's the last decimal point in exchange rates or currency pairs.

For most currencies its 0.0001. So if you bought USD/CHF 1.2475 and sold at 1.2489 you made 14 pips.

One common exception is USD/JPY. In this currency pair there are only two decimal places so a pip is equal to 0.01.

The reason pips are so important is because they are the basis for calculating profit or loss in forex trading.

Pip Value.

With all these different currency pairs to deal with and with prices fluctuating all the time, how do you know the value of a pip?

It's a simple calculation.

For currency pairs in which USD is the base currency, just divide a pip (usually 0.0001) by the exchange rate.

For currency pairs in which USD is the quote currency, its even simpler. The pip value is always one pip (for example, 0.0001).

So in our example above, when the exchange rate for USD/CHF is 1.2489:

0.0001 / 1.2489 = 0.0000800704

That's a pretty tiny number.

But remember that in forex trading you are able to leverage small sums of money to move large quantities of currency.

In other words, you can use leverage to make big profits off of that tiny number.

Let's say your forex broker allows you to trade with leverage of 100:1. This means that in order to buy a standard lot of $100,000, you only need to put up $1,000.

You can see how trading in larger lots affects the pip value, and therefore your profit or loss:

If you are only trading $1,000 in currency, the pip value is calculated as follows:

0.0000800704 X 1000 = $0.08 per pip.

The price would have to go up by a whole lot of pips in order to make a significant profit at that rate. That 14 pip profit only made you $1.12.

But by using leverage to buy a lot size of $100,000 your profit increases.

0.0000800704 X 100,000 = $8.01 per pip.

That's a profit of $112.14. Now you're talking!