As a Forex trader, there are a few fundamental concepts you must understand, like pips, lots size, and leverage. In this article, we will focus on pips. Understanding their significance not only allows you to grasp the concept of risk management but also aids in calculating profits and losses.
What Is a Pip?
A pip, short for “percentage in point,” is the smallest price movement in a currency pair in the foreign exchange market. In most cases, it is the fourth decimal place in many currency pairs apart from those that have the Japanese Yen (JPY), which takes the second decimal place in many currency pairs apart from
For example, if the GBP/USD pair moves from 1.3391 to 1.3390, it means that the price has moved by 1 pip. From 1.3371 to 1.3381, the price has moved 10 pips. With currency pairs that have the Japanese Yen (JPY), the pip takes the second decimal place, which is 0.01. For example, if the USD/JPY moves from 163.05 to 163.06, we say that it has moved by 1 pip.
These pip movements are vital in measuring profit and losses. It also helps traders to assess risk and determine entry and exit positions. For instance, if a trader spots a potential entry point at 1.2500 with a stop loss at 1.2510 and a take profit at 1.2520 (20 pips), they can calculate their risk-to-reward ratio to be 1:2. This allows traders to balance their risk and reward, ensuring they remain profitable in the market.
What Is a Pipette?
Currencies sometimes do not move much, and that is why preciseness is crucial in trading. This is where pipettes come in. A pipette is also sometimes referred to as a “fractional pip.” It is a smaller unit of measurement used to indicate precise price changes in the market, and it takes the fifth decimal place.
If a currency pair, say EUR/USD, moves from 1.23000 to 1.23001, we say that it has moved by one pipette. When it comes to YEN pairs, pipettes take the third decimal place; that is 0.001. For example, if the GBP/JPY pair moves from 195.000 to 195.001 we say it has moved by 1 pipette.
Both the pip and pipette are essential in Forex trading because they will help you acquire greater precision in your analysis, especially when you will be dealing with tight spreads.
How to Calculate Pip Value?
Pip value is basically the profit or loss you will make for one pip movement. Here is a simple example of calculating pip value:
First and foremost, you need to know that the value of a pip is determined by the exchange rate, currency pair, and the trade value or lot size you select. If you are trading a USD pair and the U.S. dollar is the quote currency, like GBP/USD, the pip takes the fourth decimal place: that is 0.0001. If JPY is your counter currency, then it takes the second decimal place, which is 0.01.
To get the value of one pip, you will have to multiply your selected trade value or lot size by 0.0001. If your lot size is 10,000 units, take that and multiply it by 0.0001, which gives you $1. This becomes the value of one pip.
The calculation is very simple;
Value Traded x Quote Currency pip = Pip Value.
10,000 x 0.0001 = 1
When the USD is the base currency, like in the case of USD/CAD, the exchange rate and trade value are also considered, but the calculation changes. This is how it goes;
(Pip size/exchange rate) x Trade Value = Pip Value.
For example, if the exchange rate of USD/CAD is 1.2527 and our lot size is 100,000, the value of a pip becomes;
(0.0001/1.2527) x 100,000 = 7.9828
This simply means that if the USD/CAD moves by 1 pip, you will make a profit of $7.98.
If you are using a mini lot, or in other words, you are selling or buying 10,000 USD against the Canadian dollar, and the price moves by 1 pip, you will make a profit of 0.7983.
(0.0001/1.2527) x 10,000 =0.7983
Other Examples:
1. EUR/USD
Assuming you are using a standard lot size (100,000) and the current price of EUR/USD is 1.25000. For every one pip movement, you will make $10. Remember, when USD is the quote currency, one pip is valued at $10 per 100,000 traded.
Value traded x quote currency pip = Pip Value.
100,000 x 0.0001 =10
This means that if the EUR/USD pair moves from 1.25000 to 1.25010, you will make a profit of $100. If you use a mini lot or trade 10,000, you will make a profit of $10 for 10 pip movement.’
2. USD/JPY
In the USD/JPY pair, pips are normally in increments of 0.01 and not 0.0001. The pip takes the second decimal place when it comes to JPY pairs. Assuming you have a standard lot size of 100,000 and the price of USD/JPY is 105.20. The value of one pip becomes;
(Pip size/exchange rate) x traded value = Pip Value.
(0.01/105.20) x 100,000 = 9.51
If, for instance, the USD/JPY price moves from 105.20 to 105.50, you will earn $285.3.
9.51 x 30 pips =$285.3
3. GBP/JPY
This is also a JPY pair, and the pip position takes the second decimal place, that is, .01. To get the value of one pip in this currency pair, you need to determine its exchange rate and your lot size. If you are buying one standard lot and the price of this pair is 125.00, then the value of one pip becomes;
(Pip size/exchange rate) x 100,000
(0.01/125.00) x 100,000 =8 GBP
So, if the GBP/JPY moves from 125.00 to 125.10, you will earn a profit of 80 pounds. That is approximately $100.39.
Pips and Profitability
Currency pairs usually move in small price increments, and these changes are measured in pips. A trader then uses the pips to calculate profits and losses. For instance, if you purchase GBP/USD, you will gain money if the pound value increases relative to the United States Dollar.
If you bought GBP/USD at 1.2525 and it moves to 1.2555, you will have made 30 pips (1.2555 -1.2525). These price changes may look small, but profit and losses do add up quickly, especially if you are trading millions of dollars.
For example, if you are trading $10,000,000 and GBP/USD pair moves by 1 pip, you will make a profit of $1000. If it moves by 5 pips, you will make $5,000. Most traders who make huge profits daily do not target high pips; 10, 20, to 30 pips is enough to make a reasonable profit in the market, especially if you have a huge account size.
Why Are Pips Important in Forex Trading?
Pips are fundamental in Forex trading because they allow traders to:
Measure Price Movements
Changes in currency pairs are mostly measured in pips. It is the smallest price change that a particular currency pair can make. These small movements in the market allow traders to discuss, measure, and compare price movements in the foreign exchange market.
Calculate Profit and Loss
Small price movements in the market also allow traders to make profits. If a trader buys EUR/USD at 1.2500 and sells at 1.2510, they gain 10 pips. They will then determine their earnings based on the lot size they were using. If they were using a standard lot size, that would mean they would have made a profit of $100.
Assess Market Volatility
Price changes in the market can help traders determine the volatility of any given currency pair. Huge pip movements in a short period show that the pair is volatile. This, in turn, allows traders to use proper risk management strategies to avoid losing a lot of money in the market.
Determine Spreads
The bid-ask spread is normally quoted in pips. The bid price is what the broker is willing to pay for the currency, and the ask price is what the broker is selling it for. A lower spread of around 1 to 2 pips is preferable as it means lower transaction costs, which can highly impact your profitability.
Accurate Entries and Exits
Forex traders also use pips to set their stop loss and take profit orders. Without understanding pips, it can be hard to place accurate entries and exits.
Conclusion
If you plan to become a successful trader it is crucial to understand how pips and pipettes work in Forex trading. It will help you gauge your profits and losses, allowing you to implement proper risk management strategies.
If you wish to learn more about Forex Trading, Audacity Capital is here to help you become consistently profitable. All you need to do is to join their Funded Trader Program or get started with the Ability Challenge.
FAQs
Are pips and pipettes crucial in Forex trading?
Understanding pips and Pipettes allows Forex traders to gauge potential rewards and implement proper risk management strategies. Traders rely on these small price movements to make informed decisions in the market before executing their trades.
Do All Currency Pairs Use Pips?
Yes, all Forex pairs use pips to measure price changes. However, the number of decimal places varies depending on the currency pair. In many currency pairs, a pip is the fourth decimal place. But for currency pairs involving JPY, a pip is the second decimal place.
Is It Necessary to Know Pip Value Before Trading?
It is important to know the pip value before placing your trade, as it allows you to know how much you will be gaining for every pip movement. This also means that you must understand lot size to accurately determine pip value.
Without understanding these key concepts in Forex trading coming up with a risk management plan will be somehow daunting. The good thing is that there are online calculators that will help you calculate pip value. Good brokers also offer pip value calculators.
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