January 26, 2010

Forex Pips Explained

If you are interested in the great money making opportunity that is forex trading, you need to understand forex pips. The word pip stands for percentage in point and so pips are also sometimes called points.

A pip is the measure of rise or fall of a currency pair. You may wonder why this is not measured in dollars and cents. The answer is that the dollar is not always the quote currency and sometimes is not involved in a trade at all. If you were trading the British pound against the Euro for example, it would make no sense to have your profits and losses expressed in US dollars.

A pip is the smallest increment of a quoted currency. Most currencies are usually quoted to four decimal places so one pip is 0.0001 units of the quote currency. What this means in practice is that if you see EUR/USD quoted at 1.4143 and a few minutes later it has moved to 1.4144, it has risen one pip.

In the case of currency pairs like EUR/USD where the dollar is the quote currency, one pip will be $0.0001 dollars or 0.01 of a cent. This does not sound like much but even in a mini forex trading account you will probably be trading in lots of $10,000 so that would be $10 on that position size.

If you want to work out your profits for a currency pair where the dollar is the base currency (the one that is given first), you need to divide 0.0001 by the exchange rate. So for example if the current exchange rate for USD/CAD is 1.1182, one pip will be CAD 0.0001. To convert to USD you divide by 1.1182 giving one pip a value of 0.0000894. This equates to US $8.94 on a $10,000 lot.

When the Japanese yen is the quote currency the position is a little different. There can be around one hundred yen to the dollar, so the quote is normally only given to two decimal places. For example you might see USD/JPY quoted at 93.72. In this case one pip is JPY 0.01. Dividing by the exchange rate gives us the value in USD of 0.0001067 per pip or $10.67 on a $10,000 lot. So having the quote to only two decimal places gives yen pairs a pip value that stays in the same ball park as the other currency pairs.

You will usually find that you do not need to do all of these calculations yourself because most brokers will provide a tool to convert your pips into profit and loss figures for the dollar (or whatever currency your funds are held in). However, sometimes you may want to work out a trade on paper and in that case you will find you need to know how to work it out for yourself. You can set up the formula in a spreadsheet so you do not have to pull out your calculator every time you want to know the value of forex pips.

Forex Pips Explained

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