You have heard about currency trading pips or pips trading while investing in currencies. But most people don’t understand the concept of pips. Let us understand pips’ meaning in trading with an example.
Understanding currency trading pips
Pips is the short form of percentage in points or price interest points. It represents the smallest unit of price change in the forex market.
In simple words, pips forex is the unit to represent the smallest change in the value of two currencies.
Usually, pips represent the fourth decimal digit of change in currency pair, except for the currency pairing with the Japanese Yen. In this case. Pip is the second decimal digit of change.
A quick glance
Pips is the short form of percentage in points or price interest points. It represents the smallest unit of price change in the forex market.
One pip equals one-hundredth of one percent, which means 1/100 of 1% or .0001.
Profit/Loss = Number of Pips* Value of Pip
A pipette is one-tenth of a pip. It is also known as fractional pips, used to represent fractional movements.
Understanding Pips forex
In the foreign exchange market, traders are engaged in buying and selling of currencies. Currencies are exchanged in pairs. Such as USD/GBP, CAD/AUD, EUR/JPY, etc.
The first currency is the base, and the second is the quote currency. The difference between the quote and base currency price is spread.
Pip is the measuring unit of this spread. Generally, price fluctuation of currency pairs takes place in small points. In order to represent these small points, we use pips in forex trading.
One pip is equal to one basis point or one-hundredth of one percent, which means 1/100 of 1% or .0001. The smallest change in currency pair is equal to .0001.
How to calculate pips in Forex
Have a look at this Pips Forex example to understand its concept more effectively. Suppose a trader is trading in USD/GBP currency pair. He first buys the pair at 1.1242, which means 1 USD = 1.1242.
After some time, he sold the pair at 1.1252. So he has made a profit of 10 pips. Or suppose he bought the pair at 1.1242 and sold it at 1.1232, which means he has suffered a loss of 10 pips.
Suppose the lot size is 100,000; that is a standard lot. In a standard lot, generally, 1 pips = 10$.
Profit/Loss = Number of Pips* Value of Pip Trader’s Proft/Loss = 10* 10$ So the trader’s profit or loss is 100$ |
Remember that the price of pips varies based on fx currency exchange rate, lot size and other variables. You can also use the Pips calculator to determine your profit or loss.
What is a Pipette?
A pipette is one-tenth of a pip. It is also known as fractional pips, used to represent fractional movements.
Pipette refers to the decimal place beyond the standard of four and two decimal to five and three decimal places used to represent currency pairs’ movements.
For example, suppose the exchange rate of EUR/USD changes from 1.11256 to 1.11258. So it is moved by 2 pipettes.
Factors that cause a change in currency trading pips
As we have studied above, your profit and loss are calculated based on the number of pips. So it is a must to understand the factor that causes changes in Pips.
Lot Size: One of the most important factors that may affect the value of pips is lot size. There are four types of lot sizes which includes standard, mini, micro and nano lots.
Standard = 100,000 units
Micro = 1000 units
Mini = 10,000 units
Nano = 100 units
Your lot size causes changes in currency trading pips. Bigger the lot size, the bigger the pip value and vice versa.
Currency Rate: The exchange rate is another factor that causes a change in pips value. The FX rate is the value of one currency against another. Higher the exchange rate higher the pip’s value.
Lower the exchange rate lower the pip’s value. Generally, the exchange rate of major and strong currencies is higher. That’s the reason why people usually invest in them.
Leverage: It allows the trader to invest in large positions with a small amount of capital or account balance. High leverage results in high pips, but remember, the amount of risk is also very high with leverage.
Currency Pair: Pips forex is also changed due to the currency pair in which you are trading. The currency pair with a high exchange rate has high pips and vice versa.
Also, usually, pips are the change in the fourth decimal digit of a currency pair. However, if your currency pair has Japanese Yen, then the pip is the second decimal digit because of the low value of Yen.
Volatility & Liquidity: It refers to how quickly the price fluctuation occurs in the market. Volatility also depends upon the type of currency pair. When there is an increase in volatility, the pips value also increases and vice versa.
Liquidity is how quickly the asset is converted into cash or easy money withdrawal. It also affects the pips’ value, and its impact is the same as volatility.
Final words
Forex trading is a process that involves continuous learning. Practical Knowledge of forex trading terminologies is necessary to understand the market and invest accordingly.
Currency trading pips play a crucial role as the number of pips helps to determine your profit and loss. The higher the number of pips gained or lost, the higher the profit or loss.
So understanding the concept of pips in the forex market and how it is calculated is a must for smart trading.