Welcome to the essential guide on understanding pips in forex trading. If you’re new to forex, you may have heard the term ‘pip’ used frequently and wondered what it means. This in-depth article will provide everything you need to know about pips – from the definition and purpose to how their values are calculated across currency pairs and how pips impact your trading.
What is a Pip?
A pip (an acronym for ‘percentage in point’) is the smallest increment of price movement for any currency pair in the forex market. It represents the digit in the fourth decimal place of a currency quote (except for certain pairs like USD/JPY where pips refer to the second decimal place).
For example, if the EUR/USD moves from 1.1200 to 1.1201, it has moved a single pip. The pip is the smallest measure that a currency can change by. Most currency pairs are quoted to four decimal places, so a pip is equal to 0.0001. The pip is very important in forex trading as it is used to calculate profits and losses.
Why Do Pips Matter?
Pips play a key role in forex for several reasons:
- They allow traders to understand the real value of price changes. Without pips, it would be difficult to calculate precise profits, losses and costs.
- Pips enable traders to set proper stop losses and take profits. You need to know the pip value to determine appropriate trade exit points.
- Pips help determine your position size for each trade. Position sizing depends on the amount of risk you want to take per pip of movement.
- Broker commissions, spreads and swap fees are often calculated based on pip movements. Knowing pip values allows you to calculate your total trading costs.
In summary, pips provide the basic unit of measurement for activity in the forex market. Whether you’re calculating profits on a trade or setting a stop loss, pips enable you to define your risk, returns and costs precisely. Mastering pips is essential for any forex trader.
How Pip Values are Calculated
The value of a pip differs across currency pairs based on two factors:
- The exchange rate between the currencies
- The lot size of the trade
Let’s look at an example to see how pip values are actually calculated:
For the EUR/USD, the exchange rate is 1.1200 (1 Euro = $1.12). The standard lot size is 100,000 units.
So for a standard lot EUR/USD trade, a one pip movement equals:
0.0001 (1 pip) x 100,000 (standard lot size) = $11
Therefore, for a standard lot on EUR/USD, each 0.0001 pip movement is worth $11.
If you trade a mini lot (10,000 units) on EUR/USD, each pip would be worth $1.1
Based on the exchange rate and lot size, you can calculate the pip value for any currency pair. Just keep in mind that pairs involving the Japanese Yen (JPY) are an exception – they are quoted to two decimal places so a pip for USD/JPY is 0.01, not 0.0001.
Pip Values for Major Currency Pairs
Now that you know how to calculate pip values, let’s look at some examples for the major currency pairs:
EUR/USD: 0.0001 x 100,000 = $11 per pip
This is the calculation we just walked through above. Remember standard lots are 100,000 units, making each pip worth $11.
GBP/USD: 0.0001 x 100,000 = $13 per pip
The exchange rate is 1.3300 (1 GBP = $1.33). So each pip is worth 0.0001 x 100,000 = $13.
USD/JPY: 0.01 x 100,000 = $11 per pip
Since USD/JPY is quoted to two decimal places, each pip is 0.01. With a standard 100k lot, that equates to 100,000 x 0.01 = $11 per pip.
AUD/USD: 0.0001 x 100,000 = $10 per pip
The exchange rate is 0.7300 (1 AUD = $0.73). So each 0.0001 pip movement equals $10 of value.
USD/CAD: 0.0001 x 100,000 = $10 per pip
With an exchange rate of 1.3000 (1 USD = 1.3 CAD), each pip on a standard lot is worth $10.
You can use this same calculation to find the pip value for any currency pair. Just remember to account for the correct decimal places and exchange rates.
How Lot Size Affects Pip Value
As the examples above demonstrate, pip values differ based on the lot size traded:
- On a standard lot (100k units) each pip is worth $10-$13
- On a mini lot (10k units) each pip is worth $1-$1.3
- On a micro lot (1k units) each pip is worth $0.10 to $0.13
The smaller your lot size, the less each pip movement is worth.
Therefore, you have to consider your lot size decided when determining pip values and ultimately, your profit and loss in trades.
If you buy 0.5 lots EUR/USD and price moves 20 pips in your favor, your gain is 0.5 x $11 (per pip value) x 20 pips = $110. But if you trade 1 full lot, your profit would be twice as much at $220 (1 x $11 per pip x 20 pips).
When setting up your trades, always crosscheck the pip value based on the exact lot size you intend to trade, rather than assuming a standard $10-$13 per pip value.
How Spreads Affect Pips & Profits
Forex brokers offer leverage to traders, but this comes at a small cost – the spread. This is the difference between the bid and ask price which represents the broker’s fee. Spreads are usually 1-5 pips on major currency pairs.
For example, if the spread on EUR/USD is 3 pips, the broker may quote the price as:
Bid Price: 1.1200 Ask Price: 1.1203
So you automatically start 3 pips in the negative on a buy trade due to the spread. This will impact your potential profits.
If you buy EUR/USD and it moves 20 pips higher to 1.1222, your actual profit is only 17 pips due to the 3 pip spread. Make sure you account for spreads when calculating potential pip profits on your trades.
Impact of Pips on Position Sizing
Position sizing refers to how many lots or units you trade on each deal. Pips play a key role in determining optimal position size based on your risk parameters. Most traders risk 1-2% of their account on each trade.
Based on your risk amount, you can use the pip value to determine appropriate trade size.
For example, if you have a $10,000 account and risk 2% ($200) per trade, you could trade 2 mini lots (20,000 units) on EUR/USD since each pip is worth around $2. This way, a 10 pip loss would equal $200.
By factoring in the pip value of your chosen currency pair, you can properly size each trading position according to your risk tolerance.
Using Pips to Set Stop Losses & Limits
Pips are also crucial for determining where to set stop losses and take profit limits when entering trades.
Stop losses protect against excessive losses by closing your trade if price moves against you by a defined number of pips.
Take profit limits lock in gains if the price moves in your favor by a certain pip amount.
You should base these exit points on the typical daily range and volatility of the currency pair. Here are some general pip settings for the major pairs:
EUR/USD
Stop Loss: 30-50 pips Take Profit: 50-100 pips
USD/JPY
Stop Loss: 30-40 pips Take Profit: 60-90 pips
GBP/USD
Stop Loss: 40-60 pips Take Profit: 80-120 pips
AUD/USD
Stop Loss: 60-100 pips Take Profit: 100-150 pips
Adjust based on your own risk tolerance, but using pips allows you to define exact entry and exit levels.
Using Pips to Evaluate Profits & Losses
One of the most vital uses of pips is to calculate your trading profits and losses. By tracking pips, you can precisely measure your performance over time.
For example, if you win 65 pips on an EUR/USD trade with 0.5 lots, your gain is 65 x $5.50 per pip x 0.5 lots = $178.75
If you lose 50 pips on USD/JPY with 1 lot, your loss is 50 x $11 per pip x 1 lot = $550
Monitoring your pip wins versus losses each week and month enables you to improve your strategy over time. You can identify which currency pairs and timeframes you are most profitable trading.
In Summary
Whether you’re an experienced trader or just starting out, having a solid handle on pip values and calculations is absolutely crucial to your success. By mastering pips you will be able to:
- Precisely calculate your profits & losses
- Determine proper position sizing and risk management
- Set effective stop losses and take profit levels
- Evaluate your trading performance and perfect your strategy
So take the time to really understand how pip values differ across currency pairs and lot sizes. Mastering pips will provide the foundation you need to trade forex effectively.
