I gave a brief description of PIPS in How The Foreign Exchange Market (Forex) Works . Now, I'll go into more detail about what they are and how they are used in Foreign Exchange Trading (FOREX).
Pip Basics
- A Pip is the smallest increment in any currency pair rate. Since a pip is the smallest increase in a rate quote, it is represented at the last digit to the right of the decimal point. For example, in the currency rate EUR / USD = 1.3904 the last digit on the right is what you will use to calculate pips. If the currency rate has only two decimal places like the USD / JPY pair (USD / JPY = 119.56) the last decimal place is still a Pip.
- Pips are used to calculate profit and loss in FOREX transactions. For example, if you buy when the rate is EUR / USD = 1.3901 and sell when the rate is 1.3906, you earn 5 pips on the trade. (1.3906 – 1.3901 = .0005 or 5 pips)
How to Calculate Pip Values (If you really want to.)
The math in this part gets just a little tiresome but there is good news: You really do not need to do these calculations yourself because most FOREX brokers do it for you, automatically . Still, the formula is offered here in case you just want to know how to do it.
So just how much in dollars is the movement of one or more pips worth-for example, per 10,000 Euros in EURUSD? How much is one pip worth per 10,000 Dollars in USDJPY? To demonstrate, we will refer to 10,000 units of the base currency, as the "Notional Amount."
The formula for calculating a pip value is:
One pip, (with proper decimal placement) / currency exchange rate) x Notional Amount
Example with USDJPY: (.01 / 130.46) x USD10,000 = $ 0.77 or 77 cents per pip
Example with EURUSD: (.0001 / .8942) x EUR10,000 = EUR 1.1183
Now, in the EUR / USD example, we want the pip value in USD, so we must multiply EUR1.1183 x (EURUSD exchange rate): EUR 1.1183 x .8942 = $ 1.00
This is a phenomenon you will see with any currency where the currency is quoted first (such as EUR / USD, GBP / USP, or AUD / USD): the pip value is always $ 1.00 per 10,000 currency units. This is why pip (or "tick") values in currency futures, where the currency is quoted first, are always fixed.
Approximate pip values for the major treaties are as follows:
(per 10,000 units of the base currency)
USD / JPY: 1 pip = $ .77. A change from 130.45 to 130.46 (1 pip) is worth about $ .77 per $ 10,000.
EUR / USD: 1 pip = $ 1.00 (.8941 to .8942 is worth $ 1.00 per 10,000 Euros.)
GBP / USD: 1 pip = $ 1.00 (1.4765 to 1.4766 is worth $ 1.00 per 10,000 Pounds.)
USD / CHF: 1 pip = $ .59 (1.6855 to 1.6866 is worth $ 59. per $ 10,000.)
At this point, you may be thinking that 1 pip multiplied by 10,000 units of a currency does not add up to much money and that you will need a lot of capital to become a viable trader! Not to worry: Take a look at Forex Math [http://bestforexstrategies.com/forex-basics/forex-math.html] to learn how leverage and margin accounts make trading in Forex work for just about everyone.
