If you are new to forex trading and decided to learn forex one of the first forex terms you will come across is the forex pip. To learn how to trade forex successfully you need to understand these terms.
What s Forex Pip?
The acronym PIP stands for Percentage In Point or Price Interest Point. In forex trading your profits and losses are measured in forex pips. Obviously it is very essential to understand what is a forex pip.
In simple terms a PIP is the smallest value (price) increment a currency can make. Forex PIP allows us to determine a rise or fall in foreign exchange values in percentage terms as an alternative of measuring in dollars and cents. Forex spreads are also measured in pips. Forex spread is the difference between the bid price and ask price (the sell quote and the buy quote) which is the major cost of currency trading. Let’s see an example to get a clear understanding. Assume that the EUR/USD quotes read 1.3300/02. In this case, the spread is the difference between 1.3300 and 1.3202, or 2 pips.
Why do we have to to measure in pips?
We use PIP in forex trading because in the currency trading market there is no universal currency in which you can indicate the foreign exchange values. Despite the fact that US dollar is the most widely traded currency, the USD is not involved in all trades. Fore instance if you are trading in two foreign currencies such as EUR/GBP or any other forex currency pairs that does not involve USD, it would not make any sense to measure your profitss and losses in terms of US dollars. Hence traders make use of forex PIP which is a small percentage of the rate of the forex currencies involved in the trade. In other words the monetary value of a forex pip changes according to the currency involved in trade.
Almost all the major forex currencies are quoted to four decimal points with the exception of Japanese Yen. For instance if the bid price for EUR/USD quoted at 1.3641 and ask price at 1.3645, then the spread (the difference between bid and ask prices) is 0.0004 or 4 pips. In terms of percentage, a pip is 0.01% of a lot. Therefore if the lot size is $100,000, one pip would be worth $10. Please note that, this is the value of pips when the US dollar is used as the quote currency. Nevertheless if the quote currency is different (example GBP), one pip is 10 units of that currency (ie 10 pounds) assuming that your lot size is 100,000.
Japanese Yen is an exception since it has a much lower unit value than most of the other major forex currencies. Due to this, the Japanese Yen is quoted to the second decimal point in forex markets. So if the USD/JPY forex rate is 110.18 then one pip is 0.01 or 1% in yen, not dollars. Accordingly the pip value is JPY 1000 which at that price would be worth US $11.015. Are still with me? I know these figures can be confusing especially for beginners.
Just remember that, in case of EUR/USD 1 pip = 0.0001 and for USD/JPY I pip=0.01.
As I always advice, it is better to trade in one forex pair, preferably in EUR/USD when you are a beginner. When you are doing currency trading in one forex pair repeatedly on a daily basis you will quickly get a clear idea of how much a pip represents in terms of your actual gains and losses. After some time you will know how much one pip is worth in dollars by taking a quick glance at your forex account.
On the other hand if you are trading in a number of dissimilar currency pairs, you are dealing with pips of different value. This will not only you get confused, you could end up losing money. Hence I recommend you to stick with the EURO/USD currency pair until you have a clear understanding of forex pip values and trends even if you are using a forex software.