A forex pip is the smallest unit of price movement in the exchange rate of a currency pair. Pip is an extremely important concept in the foreign exchange trading. Forex trading revolves around pips. Pip stands for Percentage in Points or some refer to it as Price interest point.
Pip is almost similar to the tick found in other financial markets like the futures market. Earned pips are the reward for a good trade. Traders trade foreign exchange in order to make as many pips as they can. And lost pips are the punishment for a bad trade.
Every currencys price is always expressed relative to another currency. There is no absolute currency price for US Dollar. However, you can express US Dollar price relative to Euros, British pounds, Yen, Swiss Franc and so on. It is the same with every other currency pair. Most of the currency pair exchange rates are expressed up to four decimal places. Forex pip refers to one point change in the fourth decimal place of the most major currency. Why most? Because there is a currency that is expressed up to two decimal places relative to the other currencies. Yes, Japanese Yen!
So for most of the currency pairs the exchange rate would be expressed like x.xxxx where a change of 0.0001 would constitute one pip. A pip would be the equivalent of 1/100th of one percent or one basis point. You must be familiar with the concept of basis points used in calculating thee interest rate changes.
We said almost all the currency pairs exchange rates are expressed in term like x.xxxx except those that involve Japanese Yen on either side of a currency pair. The exchange rate format would look like xxx.xx where a change of 000.01 would constitute one pip, for the handful of currency pairs featuring the Japanese Yen like GBP/JPY or USD/JPY.
Calculating the exact value of each pip for the currency pair and lot size traded is the job of the brokers trading platform which should include a pip calculator created especially for this purpose.
However, it is better that you also know how the exact value of a pip for a currency pair is calculated. Here is a simple calculation: Pip= (Lot Size) (No of Lots) (Pip Size). The result of this equation will be denominated in the quote currency.
Quote currency is the second currency in the pair. The first currency in any currency pair is known as the base currency. It is also known as the quoted currency. The second currency in the pair is also known as the counter currency. EUR is the base or quoted currency in the currency pair EUR/USD. USD is the quote or counter currency.
If the quote currency is already in US Dollar, no conversion is needed for the US Dollar denominated trading accounts. For example no conversion is needed for the currency pairs, EUR/USD, GBP/USD, CHF/USD, JPY/USD etc.
It simplifies many things for the forex traders whose accounts are primarily in US Dollar when the US Dollar is the counter currency or the quote currency. This includes heavily traded pairs like EUR/USD, GBP/USD and AUD/USD. It helps to keep in mind that all currency pairs with the quote currency as US Dollar (ending in the US Dollar) will be $10/pip for a standard lot, $1/pip for a mini lot and $0.1 for a micro lot.
Related posts:
