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As currency pairs are being traded in the Forex market, prices fluctuate and changes are measured. These changes are calculated in pips, a standardized unit in Forex transactions.
A pip, short for price interest point, points in percentage, or percentage in points, is the smallest change in the value of a currency pair. One’s understanding of pips is vital since Forex trading will always involve pips and related calculations.
What is a pip?
In its simplest definition, a pip or a percentage in point is a unit of measurement expressing the value change between two currencies. It can be measured by way of quotes or in terms of currency and expressed in decimal points up to four places. For exchange rates stated in two decimal places, a pip is equal to 0.01, while for rates stated in four decimal places, every change has a pip value of 0.0001.
A pip is typically $0.0001 for US Dollar-linked currency pairs or 1/100th of 1% or simply one basis point, which is true for most currencies. In a price quote, a pip is normally the last decimal place. For example, one pip is 0.0001 for EUR/USD. This standardised size helps prevent huge losses, thus, protecting forex investors. An exception is the Japanese Yen, which is expressed as a unit in two decimal places. For USD/JPY, one pip equals 0.01.
What is a pipette?
Currency pairs may not always be quoted in the standard two or four decimal places. Forex brokers may express quotes in three and five decimal places. These quotes refer to fractional pips, also called pipettes or points. A pipette’s value is 1/10th of a pip, which can be a bit confusing for new traders.
Let’s have an example of this: assuming that GBP/USD moves from 1.30543 to 1.30544, the change equivalent to $0.00001 is exactly one pipette. Trading platforms may state quotes in terms of pipettes.
To give you a clear idea on how to read pips, consider this rate:
1. 26394
Here’s how the rate will be interpreted in terms of pips.
4 = 0.4 pips
9 = 9 pips
3 = 30 pips
6 = 600 pips
2 = 2,000 pips
1 = 10,000 pips
Price quotes can also be divided into two parts: the handle, or the big figure, and the dealing price. For instance, in a given quote of 1.1045, 1.10 is considered the handle, and the last digits, 45, is the dealing price, which normally moves in pips. The handle changes only with a greater movement in the price of a currency, while the dealing price responds to changes in the frequent, intraday trade measured by pips.
Why use pips?
On any given day, currency trading in the global market can reach nearly 5 trillion US dollars in currency value. The smallest price change then can mean large amounts of money for any transaction in large volumes. This is why Forex trading is typically measured in smaller increments, such as 0.0001.
How is the value of a pip calculated?
When trading currency pairs, you often see quotes like this: USD/CHF 1.0491. This quote can be understood as one dollar equals 1.0491 Swiss francs. Thus, when you trade the US Dollar for the Swiss Franc, you will receive 1.0491 Swiss Francs for every US Dollar. The first currency mentioned in the quote, USD in this case, is called the base currency, while CHF is the counter or target currency. The target currency is usually expressed in a value per unit of your base currency.
To compute for pip value, let’s assume this quote is provided: USD/CHF 1.0491/95. This means that the price to sell is at 1.0491 and the price to buy is at 1.0495. The difference between them is called a spread, which is 4 pips in this case. If the bid/ask spread moves, that is 1.0501/05 now, you can buy at 1.0495 and sell at 1.0501, giving you a profit equivalent to 6 pips. To determine the monetary value of your gain or loss from trade, you just multiply the number of pips by the base currency or in this example, the US Dollar value of each pip.
While the concept of pips may seem confusing, the value of understanding how they work will bear fruit eventually. Even the most experienced trader began from scratch. Understanding how the market works and how to use the tools at your disposal begins with knowing the concepts that drive it.
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