Forex trading involves working with currency pairs and their exchange rates. When a currency pair moves, the change is measured in pips. A pip (percentage in point) is the smallest price increment in forex trading. Understanding pips is key to gauging profits and losses on trades.
In this comprehensive guide, we will cover everything you need to know about percentage in point (pip) in forex trading.
What is a Pip?
A pip (percentage in point) represents the smallest price move a currency pair can make. Pips specifically refer to the fourth decimal place in a currency pair quote.
For example, if the EUR/USD moves from 1.1200 to 1.1201, it has moved a single pip. The only part that moved was the fourth decimal place.
Pips are useful because they allow traders to precisely track profits and losses on trades down to a granular level. Without pips, it would be much harder to calculate if a trade was profitable.
Pip Values Vary By Lot Size
The value of a pip varies based on the lot size you trade. Standard lot sizes in forex are 100,000 units of the base currency. This is called a standard lot.
With a standard 100,000 unit EUR/USD lot for example, each pip movement is worth $10. This is because each pip movement of 0.0001 on a 100,000 euro lot equates to $10 (100,000 x 0.0001).
If you trade a 10,000 unit mini lot instead, each pip would be worth $1. A micro lot of 1,000 units would make each pip worth $0.10.
So it’s important to consider lot sizing when determining how much each pip is worth in your trades. The larger the lot size, the higher the value per pip.
Why Pips Matter
Pips are a simple way for traders to accurately measure and value price movements in the forex market. They allow you to determine the actual profit or loss resulting from a trade.
For example, if you go long on EUR/USD at 1.1200 with a standard lot and close your trade at 1.1250, you have a positive movement of 50 pips. Those 50 pips are worth $500 (50 x $10 per pip).
Without pip values, it would be challenging to tally up what your profit or loss is in monetary terms. Pips cut out the complexity.
How Spreads Affect Pips
It’s important to note that when you enter or exit a trade, the spread also impacts your profitability per pip. Spreads are the difference between the bid and ask prices. Your trades take place at the wider spread price, not the real market price.
For example, if the EUR/USD bid price is 1.1200 and ask price is 1.1201, the 1 pip spread means your entry and exit price is 1.1201, not the mid-market price of 1.1200.
This means your profit calculation should subtract the spread. If you buy at 1.1201 and sell at 1.1251, your real gain is only 49 pips due to the 2 pip spread impact.
Always account for spread when determining your true pip profit or loss.
Pips In Action On Long vs Short Trades
Let’s take a look at how pips work on both long and short trades:
Long EUR/USD Trade
- Entry price: 1.1200
- Exit price: 1.1250
- Pip Movement: 50 pips
- Profit: $500 ($10 per pip x 50 pips)
Short EUR/USD Trade
- Entry price: 1.1200
- Exit price: 1.1150
- Pip Movement: -50 pips
- Profit: $500 ($10 per pip x 50 pips)
As you can see, pips function the same in both long and short trades. A positive pip movement results in a profit, while negative pips mean a loss. Regardless of direction, pip values remain constant based on lot size.
Factors That Impact Pip Movement
Several factors can lead to pip movements in currency pairs:
News/Data Releases: Major news events like employment data or interest rate decisions can cause significant pip movements. Volatility tends to spike around these events.
Technical Levels: Key technical levels like support, resistance or trend lines often lead to accelerating pip movements as large numbers of orders are triggered.
Intervention: Central bank intervention via interest rates or monetary policy shifts can lead to major long term pip trends. Quantitative easing for example can weaken a currency.
Sentiment: Shifting market sentiment or risk appetite will see flows in and out of currencies, leading to extended pip runs. Risk aversion may lift safe haven currencies for instance.
Orders: Built up stop or limit orders around key levels lead to cascading pip movements as one order triggers the next. This can accelerate trends.
Traders should monitor these catalysts and be aware of upcoming events that may cause significant pip action.
Pips In Major, Minor and Exotic Currency Pairs
Pips function the same way across all currency pairs, but their values differ:
Major Pairs: EUR/USD, USD/JPY, GBP/USD, USD/CHF – These have the lowest pip values due to minimal volatility and narrow spreads. Each pip may be worth $10 or less depending on lot size.
Minor Pairs: EUR/GBP, EUR/AUD, EUR/CAD, GBP/JPY etc. – More volatility means wider spreads and higher pip values. Each pip may be worth $20-$30.
Exotics: USD/TRY, USD/ZAR, USD/MXN etc. – Exotic emerging market currencies see huge volatility and spreads. Pip values can be $50+ due to uncertainty and risk.
Volatility is the major factor impacting pip values. Currency pairs that see larger moves have wider spreads, leading to higher per pip costs.
Pip Values In Equity, Commodity and Cryptocurrency Trading
While pips are most commonly discussed in forex, they can also be used in other markets:
Equities: Pips in equity trading refer to a stock price’s smallest movement (usually $0.01). A 10 cent rise in a share price would equal 10 pips.
Commodities: Gold for example is priced to the penny, so pip movements represent a $0.10 change in price. Natural gas futures see 0.001 increments, making a single pip worth $0.001.
Cryptocurrencies: Prices are tracked to many decimal places. A one pip change in Bitcoin would be a move of $0.01 cent. More volatile coins like Dogecoin may see 1 pip = $0.0001 due to wild swings.
So pips can apply to any instrument with fractional pricing. The values vary widely based on specific contract specifications and volatility.
Key Takeaways on Percentage in Point
A few key takeaways on working with percentage in point:
- Pips allow traders to precisely track profits, losses and directionality down to an incremental level.
- Lot sizing directly impacts the monetary value of each individual pip movement.
- Spreads slightly reduce profit per pip – always account for spread impact.
- Major economic events, technical levels and market volatility all drive pip action.
- Exotic currency pairs will have higher pip values due to wider spreads and volatility.
- Pips apply to any financial instrument priced fractionally, not just forex.
Understanding pips ultimately helps traders improve risk management and accurately evaluate trades. Mastering pip values is a key forex skill every trader should possess.
Conclusion
Percentage in point represents the smallest measurable move in a currency pair. While the concept is simple, pips are critical to forex trading. They allow traders to precisely track profits and losses down to granular increments based on defined lot sizes.
Factors like news events, economic data, technical levels and sentiment all drive pip volatility. Being aware of potential catalysts is key. Higher risk exotic pairs will naturally see wider pip swings due to uncertainty. Across all instruments, pips provide an indispensable benchmark for quantifying risk and trade outcomes.