What is a pip?

What is a pip?

A pip is the smallest recorded fraction of a currency’s value. In most cases, a pip is equal to 0.0001, as values are given to the fourth decimal point. There are, however, exceptions, such as the Japanese yen (JPY), where a pip is recorded as being worth 0.01 JPY. Pips are used in foreign exchange trading. The word pip is an acronym, standing for price interest point or percentage in point. 

Highlights 

Understanding forex pips

As an example, in a EUR/USD trade, both the US dollar and the euro are measured to the fourth decimal point. So if the euro is trading at 1.0040 against the dollar and then goes up to 1.0048, it is a change of eight pips.

Although most forex brokers quote currency pairs in the standard four or two decimal places, there are some who use five and three decimal places. They usually quote fractional pips, also known as pipettes.

A pipette, or a fractional pip, is equal to a tenth of a pip. For example, if a GBP/USD currency pair falls from 1.21168 to 1.21166, this .00002 USD move can be called two pipettes rise.

Why use pips?

Pips in forex trading are used to measure gains and losses because, a lot of the time, the volatility in exchange rates is on such a minute level that pips make for an appropriate measurement.

In Japanese yen, one pip equals 0.01 JPY because the Japanese currency is worth relatively little compared to the likes of the US dollar, the British pound, and the euro. 

Factors that affect pip value

The value of a pip depends on the factors specific to your trade: 

• Currency pair: The actual currencies that are being used can have an impact on the forex pip’s value. If your account was funded in US dollars, and, for example, you had the EUR/USD pair, and you bought $100,000 worth of euros against the dollar at $1.0001 and sold them at $1.0006, then you would have, theoretically, made $50, or  five pips, at $10 value each. The calculation of the pip value is the pip, in this case 0.0001, multiplied by the lot size.

• Exchange rate: The exchange rate also has an effect on the value of a pip. If we are funding a trade in dollars but we have a pair where USD is the base currency, which means the trade is essentially measured in another currency, we have to convert USD into it. For example, with the USD/CAD pair, you would have to divide the size of a pip by the exchange rate and then multiply it by the value of a trade. If the exchange rate was 1.2829 and you had a lot of $100,000, then the value of a pip would be $7.79, or 0.0001 divided by 1.2829 and then multiplied by $100,000. 

• Overall trade value: The overall value of the trade being carried out affects the value of a pip. For instance, if we were trading with a lot worth $100,000, then a pip would be worth $10, or $100,000 multiplied by 0.0001. If, on the other hand, we were to use five standard lots, then the pip would be worth $50, or $500,000 multiplied by 0.0001

• Use of leverage:  The use of leverage, or borrowing money in order to trade or invest with it, can have an impact on a pip’s value. As we will see below, leverage can increase the fundamental value of a pip, making trading much riskier. Leverage can magnify both profits and losses.

How does leverage change pip value

Leverage, or borrowing money from your broker in order to trade it, can magnify both profits  and losses. Yet it can also affect the value of a pip as it increases the lot size.

For instance, if you have a standard trading lot size of $100,000, then a pip would be worth $10, or $100,000 multiplied by $0.0001. However, if you used leverage at a ratio of 150:1, this would increase your lot size to $1.5m, then the pip would be worth $150, or $1.5m multiplied by $0.0001. While this might sound like it could be more profitable, it could also cause more losses, as your account could be wiped out if funds at a faster pace. 

In another example, if you choose a more moderate leverage level, for instance of 2:1, this would increase your lot size to $200,000 and hence your pip value to $20. Remember, leverage can magnify both profits and losses.

Leverage	1:1	2:1	150:1
Lot size	$100,000	$200,000	$1.5m
Pip value	$10	$20	$150

How to calculate the value of a pip

Let’s imagine your forex account is funded in British pounds and your trade involves GBP. Your calculation could go three ways:

1. When GBP is your quote currency

When GBP is your quote currency, working out a pip’s value is fairly straightforward. If, for instance, you were trading EUR/GBP and you bought £100,000 worth of euros at £1.0002 and sold them at £1.0015 then you would have made £130 or 13 pips. To find out one pip’s value, you multiply the pip (0.0001) by the lot size (£100,000), which is £10. Your profit is the value of the pip multiplied by the pip difference, or 13 * £10. 

 

2. When GBP is your base currency

When GBP is your quote currency, then you have to factor the exchange rate in. If you were trading GBP/USD and you had an exchange rate of 1.2, and bought £100,000 worth of dollars, then a pip would be worth £8.33, or the pip (0.0001) divided by the exchange rate (1.2) and then multiplied by the size of the lot (£100,000). 

 

3. When JPY is involved

Things are a little different when the Japanese yen is involved. This is because the yen is worth comparatively little and its pip only goes to the second decimal place. In this case, the value of a pip is 0.01 divided by the exchange rate multiplied by the lot size. If, for instance, the exchange rate was 152.25 and you bought £100,000 worth of yen, then a pip would be worth a little under £6.57.

Pips vs Points vs Ticks

It’s important to highlight that pips are neither points nor ticks. Both points and pips can be used in a wide range of markets, while pips are the measurement used when comparing forex rates specifically. 

In trading, a point is the number to the left of the decimal point. So, for instance, if you have 1.2345, then the one is the point. If we were to talk about a price rise from $1.2345 to $2.2345, then the price has risen by one point. 

A tick, on the other hand, measures the smallest possible incremental price change on the right side of the decimal point. For instance, if we were to have something whose price was measured in thousandths of a dollar, if it moved from $1.234 to $1.235, then we would say that it had moved up by one tick. 

Conclusion

In forex, pips are the crucial element that, ultimately, measure a trader’s profit or loss. They are the smallest decimal point of a quoted currency price, normally at the fourth number after the decimal point (0.0001), however, the second for JPY (0.01).

Some brokers may also use pipettes, which are fractional pips equal to a tenth of a pip. 

Remember, there are a number of factors that can affect the pip’s value, including the currency pair traded, its exchange rate, the overall trade value - or lot size, and whether leverage was used.

It’s important to always conduct your own due diligence before trading, and never trade more money than you can afford to lose.

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