What Is a Pip In Forex?

When you step into the world of forex trading, there are certain terms and ideas that you need to wrap your head around to steer through the market smartly. One of these crucial terms is “pip.” This thorough guide will dig into what pips signify, why they hold weight in forex trading, and how to work out their value.

By the time you’re done reading, you’ll have a clear handle on pips and how they factor into making profits in the forex market.

What is a Pip?

“Pip” is an acronym for “percentage in point” or “price interest point.” So, it is the smallest item to measure price movements in the forex market. Pips are typically the last decimal place of a price quote, except for Japanese yen pairs, which are quoted to two decimal places. Mostly, a pip equals 0.0001, while a pip is equivalent to 0.01 for yen pairs.

It’s crucial to note that pips should not be confused with basis points (bps) used in interest rate markets to represent 1/100th of 1%. Pips, on the other hand, are specific to forex trading and are used to measure the price change increment for currency pairs.

How Pips are Calculated

Understanding how to calculate the value of a pip is essential for managing risk and determining potential profits or losses in forex trading. The value of a pip depends on various factors, including the currency pair, exchange rate, and trade size. Let’s explore how to calculate pip value using a few examples:

Example #1: USD/CAD

For example, the USD/CAD currency pair’s exchange rate is 1.3500. In this case, the pip value can be calculated by multiplying the trade size (or lot size) by 0.0001. For instance, if you are trading 10,000 units of USD/CAD, the pip value would be:

Pip value = 10,000 * 0.0001 = 1 CAD

Example #2: EUR/USD

Let’s consider the EUR/USD currency pair, where the exchange rate is 1.1800. If you are trading 20,000 units of EUR/USD, the pip value would be:

Pip value = 20,000 * 0.0001 = 2 USD

Example #3: GBP/JPY

Japanese yen pairs have a slightly different pip calculation due to their exchange rate format, which is quoted in two decimal places. Let’s take the GBP/JPY currency pair, where the exchange rate is 150.50. If you are trading 30,000 units of GBP/JPY, the pip value would be:

Pip value = 30,000 * 0.01 = 300 JPY

It’s important to note that the pip value will fluctuate as the exchange rate changes. Therefore, it’s crucial to stay updated with real-time exchange rates and adjust your calculations accordingly.

Real-World Examples of Pip

Over time, numerous instances in the real world have emphasized just how vital pips are within the forex market. These examples showcase extreme cases where exchange rates experienced drastic changes, making pips a crucial metric for understanding the magnitude of such fluctuations.

Example #1: Weimar Republic Hyperinflation

A well-known historical example of hyperinflation and devaluation occurred in Germany’s Weimar Republic. Before World War I, the exchange rate stood at 4.2 marks per dollar. However, by November 1923, it had collapsed to 4.2 trillion marks per dollar. This extreme devaluation made pips almost irrelevant due to the unmanageable exchange rate.

Example #2: Turkish Lira Devaluation

In 2001, the Turkish lira reached 1.6 million per dollar, rendering many trading systems ineffective. The Turkish government eliminated six zeros from the exchange rate to combat this issue and introduced the new Turkish lira. As of January 2021, the average exchange rate is more reasonable 7.3 lira per dollar.

Conclusion

Grasping the concept of pips is like having a compass in the forex market, guiding trading decisions. A pip acts as the building block for measuring currency movements in forex. It’s the tiniest price shift that a currency pair experiences according to market standards. Getting a handle on pips is a must for forex traders; it empowers them to evaluate potential profits or losses and navigate their risk and leverage with confidence.