When trading in the Forex market, you need to have a close eye on two currencies at the same time. PIP helps you denote the change in a currency pair’s value. While trading in the Forex market, one must be aware of high volatility levels and the high price movements of several PIPs in a short duration of time.
Even though it is an extremely low unit of measurement, it is imperative for Forex traders to know what is PIP in detail. Forex traders are highly leveraged in most trade-deals, and even the slightest PIP movement or difference brings a significant profit or loss to them. It makes it clear for the trader to understand exchange rate movements, enabling them to manage risks efficiently.
A Percentage in Point, also known as PIP in short, is the slight change in the currency pair trading in a Forex market. It is measured either in terms of the particular quote or the underlying currency. A PIP measures every movement in the currency exchange rate.
PIP is the smallest amount by which a currency quote can change and is always measured as a standardized unit. For example, a PIP is usually $0.0001 for all the currency pairs related to the US dollar. This is also known as 1/100th of 1%, one basis point. This size helps the investors from bearing heavy losses. This means, if a PIP is 15 basis points, a single PIP change causes greater volatility in the currency values when compared to a PIP with only one basis point. The lower the PIP, the less risky currency trading becomes.
The slightest change for most currency pairs is 1 PIP since most of these currencies are quoted up to 4 decimal points.
The monetary value of each PIP depends on the currency pair being traded, the size of that trade and the prevailing exchange rate. Here os a stepwise guide on how to calculate PIP:
Step 1: Determine your PIP size., since most currencies are quoted up to 4 decimal places, it is 0.0001 for most of the currencies except for the ones that contain the Japanese Yen. Since the Japanese Yen is relatively lower in value, it is mostly 0.01 for the same.
Step 2: Determine the exchange rate of the currency pair.
Step 3: Use the formula of calculating the PIP value for a position –
PIP value = (PIP size/exchange rate) * position size
Step 4: Convert the PIP value that you get into your country’s currency by using the current exchange rate.
Let us assume that we have a currency pair of USD/EUR, with a direct quote of 0.7747. this means that for $1, a trader can buy around 0.7747 euros. Now let us consider that there was a PIP increase of 1-PIP, increasing the quote to 0.7748. the value of the US dollar would then rise relatively, as now $1 enables the trader to buy more euros (0.7748) than before.
Continuing with our example above, the overall effect a one-PIP change has on the dollar amount or the entire PIP value will depend on the total number of euros purchased. The higher the volume, the greater the effect.
If an investor purchases 10,000 euros with the said dollars, the price would be = $12,908.22 ([1/0.7747] * 10,000).
When the exchange rate for this particular pair experiences a one PIP increase, the price that will have to be paid will be $12,906.56 ([1/0.7748] * 10,000).
This signifies that the PIP value on a total of 10,000 euros will be $1.66 ($12,908.22 - $ 12,906.56). however, the same investor purchased, let's say, 100,000 euros at the same price; the PIP value would have been $16.7. This would mean that the PIP value would increase depending on the amount of the underlying currency, euros, in our case, and also has effects based on the purchase size of the currency.
The loss or profit the trader makes depends on the currency pair’s movement. If a trader buys USD/EUR, they will profit if the dollar increases in value when compared to the euro. For example, if the trader bought the dollar for 1.1835 and exited at 1.1901, the trader would end up making 66 PIPs (1.1901-1.1835) on the entire trade.
However, things are different when one of the currency pairs is the Japanese Yen. If a trader buys the Yen by selling USD/JPY at 112.06, he will lose 3 PIPs on the entire trade if it is closed at 112.09. On the other hand, the trader will profit by 5 PIPs if the position is exited or closed at 112.01.
These profits and losses look pretty small when seen with a single trade perspective. However, gains and losses add up quickly in the multi trillion-dollar foreign exchange. If a $10 million position in the example above is closed at 112.01, the trader books a profit of 500,000 yen ($10 million [112.06 – 112.01]). The same profit, when calculated in dollars, will come out to be $4,463.89.
Through this article, we can conclude what PIPs are and how they work. PIPs result in profits and losses in the foreign exchange market, the volume of which depends on the trade size. It is essential for a Forex trader to critically understand what PIPs are and how they would affect trade to protect themselves against heavy losses and enjoy substantial profits. Our Forex trading platform enables hassle-free trade with transparent guidelines that ensure your Forex trade is not only unbiased but also ethically regulated.
Master risk management and become an expert Forex trader. Move on to the advanced course.Go To Course
Enter your details to get a copy of our free eBook
Thank you, please check your inbox for your ebook