Pips in Forex Trading – Everything You Need to Know
For beginners, forex trading may seem overwhelming. To grasp this seemingly complex concept, one must first familiarise oneself with numerous terms and nuances, including the…
For beginners, forex trading may seem overwhelming. To grasp this seemingly complex concept, one must first familiarise oneself with numerous terms and nuances, including the term ‘pip’.
But what exactly is a pip in forex trading? And how do you calculate its value? In this article, we’ll break down everything you need to know about pips in forex trading. So, let’s start from the basics!
What is a Pip?
A pip, short for ‘percentage in point’ or ‘price interest point’, is a unit of measurement used to track price movements in the foreign exchange market. It represents the smallest change in value of an exchange rate and varies from asset to asset.
Typically, a pip is represented as such in the following markets:
- When USD is the Quote Currency (Ex. EUR/USD): 0.0001
- When JPY is the Quote Currency (Ex. USD/JPY): 0.01
So, if the EUR/USD currency pair moves from 1.0550 to 1.0555, there has been a change of 5 pips. Then, if the USD/JPY pair moves from 141.20 to 141.26, there has been a change of 6 pips.
Pips are typically used to describe the distance of price movements, or size of spreads in a tradable asset. Let’s consider an example on EUR/USD:
- Price of EUR/USD: 1.0550
- Ask price (buy): 1.0552
- Bid price (sell): 1.0548
- Spreads would then equal to: 0.0004, which is 4 pips
What is a Pipette?
A pipette, a fractional pip or point, is the fifth decimal place in a currency pair’s exchange rate. It represents a tenth of a pip and is used when measuring very small price changes. For example, if the EUR/USD exchange rate moves from 1.05500 to 1.05505, that is a change of 0.5 pips or 5 pipettes.
How to Calculate the Value of a Pip
The value of a pip is determined by the size of your trade and the currency pair you are trading.
When USD is the Quote Currency (Major Pairs)
When the Forex pair you’re trading has USD as the quote currency, a pip is denoted as 0.0001 in the price.
Since pip values are typically calculated in USD, the formula to get them becomes very straightforward – simply multiply your lot size by 0.0001 to get the value per pip.
So if you traded 1 Lot on EURUSD, your value per pip would be $10 dollars, which represents how much your trade earns or loses with every pip movement.
Value per pip = 0.0001 x Lot size
| Example: 1 Lot on currency paired against USD Value per pip = 0.0001 x Lot Size = 0.0001 x 100,000 = $10 dollars |
When USD is NOT the Quote Currency (Cross/Exotic Pairs)
When trading a Forex pair where USD is not the quote currency, a pip could be denoted to a different decimal place. For instance, if JPY is the quote currency, a pip is denoted as 0.01 due to the different decimal structure of yen-based pairs.
If you are not trading in USD, you can convert the value per pip into your base trading currency. With all this in mind, the formula ends up looking like this:
Value per pip = Pip denotation x (Lot size / Exchange Rate)
| Example: 1 Lot on USD/JPY (Current Value ¥145) Value per pip = 0.01 x (Lot Size / Exchange Rate) = 0.01 x (100,000 / ¥145) =$6.90 |
By accounting for exchange rate, your pip value comes down to $6.90 US Dollars, per 0.01 price change on USD/JPY, when trading 1 lot at the price of ¥145 yen per dollar.
How to Calculate Lot Size Based on Pip Value
Knowing the value per pip calculation means we can reverse engineer this calculation to get the lot size. This is useful for traders who are already in a trade with a stop loss.
Calculating the Lot Size:
Lot Size = Risk Amount / (Value per pip x Stop Loss)
| Example: EUR/USD Risk Amount: $200 Stop Loss (SL): 20 pips Pip value for EUR/USD (per standard lot): $10 Lot Size = Risk Amount / (Value per pip x Stop Loss) = 200 / (10 x 20 pips) = 200 / 200 = 1.0 Standard Lots If you’d risk $200 on this trade, the appropriate lot size would be 1 standard lot. |
This calculation method is applicable for major pairs, and even cross pairs, and exotics as well – given that the pip value of the cross/exotic pair is properly calculated.
Here’s how that might look like:
| Example: USD/JPY Risk Amount: $200 Stop Loss (SL): 20 pips Pip value for USD/JPY (per standard lot): $6.90 Lot Size = Risk Amount / (Value per pip x Stop Loss) = 200 / (6.90 x 20) = 200 / 138 = 1.45 Standard Lots Rounded Up If you’d risk $200 on this trade, the appropriate lot size would be 1.45 standard lots. |
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