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Pip Definition and How They Work in Currency Pairs

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A “pip” stands for “percentage in point” or “price interest point.” It’s the smallest price change in the exchange rate of currencies, according to how the forex market works.

Most currency pairs have prices listed with four decimal places. A single pip is the fourth decimal place, which means it’s 1/10,000th of the exchange rate. For instance, in the USD/CAD pair, the smallest change possible is $0.0001, or one pip.

Pips are important in forex trading. They shouldn’t be mixed up with “bps” (basis points), which are used in interest rate markets. Bps represent 1/100th of 1%, or 0.01%.

Understanding Pips

A pip is an important idea in foreign exchange (forex) trading. In forex, traders exchange one currency for another, and the value of one currency is compared to another. The prices for these pairs are shown as bid and ask spreads, which are precise to four decimal places.

Pips measure how the exchange rate moves. Because most currency pairs are shown with up to four decimals, the smallest change possible for these pairs is one pip.

Calculating Pip Value

The value of a pip changes based on the currency pair, the exchange rate, and the trade size. When your forex account is in U.S. dollars and USD is the second currency in the pair (like in EUR/USD), each pip is fixed at .0001.

To figure out the value of one pip in this case, you multiply the trade size (or lot size) by 0.0001. For example, if you’re trading 10,000 euros against the dollar, the pip value is $1. So, if you bought 10,000 euros at 1.0801 and sold at 1.0811, you’d make a profit of 10 pips or $10.

However, when the USD is the first currency in the pair (like in USD/CAD), the pip value also considers the exchange rate. You divide the size of a pip by the exchange rate and then multiply by the trade size.

For instance, if the pip size is .0001 the USD/CAD exchange rate is 1.2829, and you’re trading a standard lot size of 100,000, the pip value is $7.79. So, if you bought 100,000 USD against the Canadian dollar at 1.2829 and sold at 1.2830, you’d make a profit of 1 pip or $7.79.

JPY Exception

Pairs involving the Japanese yen (JPY) are different because they’re quoted with only 2 decimal places, unlike the usual four. For currencies like EUR/JPY and USD/JPY, each pip’s value is 1/100 divided by the exchange rate.

For instance, if the EUR/JPY is at 132.62, one pip equals 1/100 ÷ 132.62 = 0.0000754. If you’re trading 100,000 euros, the value of one pip (in USD) would be $7.54.

Pips and Profitability

The way money changes between currencies decides if a trader gains or loses money. For instance, if someone buys euros with U.S. dollars, they win when the euro’s worth goes up compared to the dollar. Imagine a trader who buys euros at a rate of 1.1835 dollars per euro. If they sell them later at 1.1901 dollars per euro, they make a profit of 66 pips (1.1901 – 1.1835).

Now, let’s talk about another trader who sells U.S. dollars to buy Japanese Yen at a rate of 112.06 yen per dollar. If they close their trade at 112.09 yen per dollar, they lose 3 pips. But if they close it at 112.01 yen per dollar, they gain 5 pips.

Even though the differences seem small, in the foreign exchange market where trillions of dollars are traded, these gains and losses can become significant. For instance, if a trader closes a $10 million position at 112.01 yen per dollar, they make ¥500,000. That’s equal to $4,463.89 in U.S. dollars (¥500,000 divided by 112.01).

Real-World Examples of Pip

When hyperinflation and devaluation happen together, exchange rates can become very difficult to handle. This affects consumers who have to carry a lot of cash. It also makes trading very hard, and the concept of a pip doesn’t matter anymore.

A famous example of this happened in Germany’s Weimar Republic. Before World War I, the exchange rate was 4.2 marks per dollar. But in November 1923, it collapsed to 4.2 trillion marks per dollar.

Another example is the Turkish lira. In 2001, it reached a level of 1.6 million lira per dollar. Many trading systems couldn’t deal with such high numbers. So, the government changed things. They removed six zeros from the exchange rate and called it the new Turkish lira. By January 2021, the average exchange rate became more reasonable, at 7.3 lira per dollar.

What’s a Pip?

A pip is the tiniest unit to measure the difference between the bid and ask prices in a foreign exchange quote. It equals 1/100 of 1%, which is .0001. So, forex quotes have four decimal places. Even smaller price changes are called fractional pips, or “pipettes.”

What Is the Difference Between a Pip and a Pippette?

In the foreign exchange market, a pip is a standard unit used to measure changes in an exchange rate. It represents a move of 0.0001 (which is 1/10,000). For most currency pairs, this is the smallest increment of price change.

A pipette, on the other hand, equals 1/10 of a pip and it represents a fraction of 1/100,000.

So, a pip measures movement in the fourth decimal place, while a pipette measures movement in the fifth decimal place.

How Are Pips Used?

Pips are like tiny parts of a currency pair’s exchange rate. They show how the quote changes in the market. Let’s imagine you bought a currency pair at a rate of 1.1356 and then sold it at 1.1360. That means you gained 4 pips from your trade. To figure out how much money you made, you need to calculate the value of one pip. Then, you multiply that by the size of your trade to know the dollar value of your profit.

Does the Japanese Yen Forex Rate Use Pips?

Yes, it does. However, the yen is an exception. A quote for the yen normally extends two decimal places past the decimal point. So, a single whole unit pip is .01 rather than .0001 for other currency pairs.

Conclusion

Pips are important in the forex market. They help traders make decisions. A pip stands for “Percentage in Point” and it’s a basic way to measure currency movements. It’s usually the smallest price change that happens in the forex market based on common practice. Knowing about pips is super important for forex traders. It helps them figure out how much they could gain or lose and helps them handle their leverage and risk better.

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