What pips are?
The Forex market is a place where there are wide-scale buying and selling of currencies. The exchange of currencies is done between many different participants that may include individual traders, investors, trading firms, investment banks, and commercial banks. The Forex market is known to be the most liquid among all the other types of financial markets.
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The Essential Need to Understand the term ‘PIP’ in Forex Trading
According to a survey by Bank of International Settlements, the average daily trading volume was an astounding $6.5 trillion in 2019. It is estimated that a Forex market sees daily transactions close to about £4 trillion. Over the counter (OTC) trading is common in certain markets such as the forex where trading is usually done through brokers or online platforms.
Forex trading is done among particular currencies known as ‘Majors’ that have a substantial value against other currencies. The currency exchange is done in pairs. The common global currencies that are traded are British Pound (GBP), U.S Dollar, Swiss Franc (CHF), Australian Dollar (AUD), Euro (EUR) and Japanese Yen (JPY).
The currency is traded in pairs such as GBP/USD, EUR/USD, USD/JPY, and AUD/USD. The key to forex
trading lies in correctly predicting a rise in the value of one currency against the other. For
example, if the British economy is said to rise as compared to the U.S economy, you would ‘Buy
GBP/USD.’ Similarly, if the British economy is showing a decline, you would ‘Sell GBP/USD.’
The Value of Pip in Forex Trading:
To trade in a Forex market, you need to know the importance of ‘Pip,’ which is an abbreviation of Percentage in Point and means the smallest price change that a given exchange rate can make. An increase or decrease in Pips shows the profit or loss that you can make in the Forex trade.
Usually, the currencies to be exchanged are quoted to the fourth decimal place. The exceptions to the four decimal rules include Japanese Yen, gold, oil, and gas that are quoted to two decimal places. Pip is a benchmark unit that denotes how much a currency quote can change.
Pip is usually represented by 1/100 of 1%, or only one basis point. Pip is denoted by $0.0001 for U.S Dollar led currency pairs. The standard 1% is kept to prevent the investors from sufficient losses. For example, an exchange rate between British Pound and U.S Dollar will be shown as
GBP/USD = 1.2500 or (1 GBP/1.2500 USD)
If previously the rate was 1.2500, and the current price is 1.2501, we say the value has moved one
Pip as the fourth decimal value has increased by 1.
How to Calculate the Value of a Pip
If we take the GBP/USD pair, it has a current exchange rate of 1.2500. If one Pip equal to 0.0001, we divide 0.0001 with 1.2500. The answer or the Pip value comes to be 0.00008. To see if it is a profit or loss, we examine it under certain conditions or deals.
- Deal-1
As a Forex trader, if you are looking for a quote on GBP/USD, you will see its exchange rate that is 1.2500. If you want to buy £10,000 worth of US. Dollars, at the quoted price the calculation you would do is
(1/1.2500) * (£10,000) = £8,000
It means you would pay £8,000
- Deal-2
As you are calculating, the GBP/USD pair sees a one Pip increase to quote at 1.2501, which represents that the British pound is appreciated against the U.S Dollar. The new calculation would be
(1/1.2501) * (£10,000) = £7,999.36
It means you would pay £7,999.36
Conclusion:
The difference between the Deal-1 and Deal-2 is just 36 cents, but when this position is leveraged 50 times it is £1,800, and one Pip value is £18
In the Forex market, currencies can easily move close to 70 Pips a day, as there is considerable leverage for forex traders, even a point difference can result in significant profit or loss.
Why the Need to Know Pip Value:
In a large Forex market, the currencies are exchanged quite frequently, and the transaction is necessary to help international business and trade. The Forex trading is based upon a set of predefined amounts of currency that you can trade in. There are two types of contracts that most brokers offer depending on the size of the contract, which are Standard Lot and Mini Lot.
The Standard Lot has contract size or number of units in the base currency of 100,000, while the Mini Lot has a contract size of 10,000.
Pip Value = One Pip x Contract or Lot Size
Pip Value = 0.0001 x 100,000
Pip Value = $10
When trading, if one Pip moves in your predicted direction, it means a $10 profit in your account. Similarly, if one Pip moves against your guess, it means a $10 loss from your account.
The information above is for education purposes only and cannot be considered as investment advice. Past performance is not reliable indicator of future results.
