What Is a Pip in Forex Trading?

Before blindly jumping into the exciting world of the markets, it is important to properly educate yourself on the vocabulary and concepts that will accompany us daily on your trading journey. Indeed, new traders can be easily overwhelmed as they first enter the markets, and this brief lesson is aimed to help them along the way. In this article, we will go quite in depth into the notion of pips in forex trading, from the definition of a pip and pipette to the calculation of pip value, position size and even forex price moves. I invite any future trader to thoroughly read this piece of information since it is essential to their future profitability in the forex market.

What is a Pip ?

Let’s start from the beginning by defining the very meaning of the acronym pip. Pip stands for Percentage In Points or Price Interest Point and is widely used in finance, especially in the Foreign Exchange, as a means to measure the smallest price move that an exchange rate can make based on forex market conventions. You can easily spot it in a typical forex quote as a single digit move in the fourth decimal place.
For example, if the price of EUR/USD moves from 1.1402 to 1.1403, this would be a one pip or “point” movement.

However, there is an exception to this rule when dealing with the Japanese Yen. While trading the yen, you’ll have to look at the second decimal place instead of the fourth, because this currency is much closer in value to one hundredth of other major currencies. Let’s look at an example to put this difference in perspective.

If the price of USD/JPY moves frome 107.88 to 107.89, this would be a one-pip or “point” movement.

What is a Pipette?

Now that the notion of pip is clear in your mind, we can look at its little brother, the pipette. A pipette in forex is simply one-tenth of the value of a forex pip and is only noticeable for 5-digit brokers since the pipette appears as the fifth decimal digit placed in the currency pair exchange rates. As seen on an applicable forex broker:

For example, if the price of EUR/USD moves from 1.14023 to 1.14024, this would be a one-pipette movement.

As you probably already guessed, the Japanese Yen remains the exception here. The pipette will appear as the third decimal digit placed in the currency pair exchange rates instead of the fifth. You might observe the following on an applicable broker:

If the price of USD/JPY moves from 107.886 to 107.887, this would be a one-pipette movement.

How to Calculate the Value of a Pip

It’s about time we dove into the practical use of pips and learned how to effectively calculate their value. There are three main factors to take into consideration when it comes to calculating the value of each pip: the currency pair, the lot size and the exchange rate. You will have to follow these 4 steps rigorously:

• Determine the pip size. It will be one pip that is 0.0001 for all regular currency pairs, keeping in mind any pair containing the Japanese Yen has a pip size of 0.01.
• Determine the exchange rate.
• Use the following formula for calculating the pip value for a specific position size: Pip value = (pip size / exchange rate) x position size
• Convert the pip value into your account currency using the prevailing exchange rate.

Let’s look at some pip value calculation examples:

EUR/USD

Assuming a standard 100,000 lot size, and a EUR/USD price of 1.4000, account denominated in USD:

Pip value = (0.0001 / 1.4000) x 100,000

= $7.14 pip for a standard lot

= ($0.74 pip for a mini lot or $0.074 pip for a micro lot)

If it is in EUR or JPY, then you’d need to convert the $7.14 into that currency. For example, if the account is denominated in EUR, then:

= $7.14 x 1.4000 dollars per Euro

= €10.00 / pip / standard lot

= (€1.00 / pip / mini lot or €0.1000 / pip / micro lot)

USD/CAD

Assuming a standard 100,000 lot size, and a USD/CAD price of 1.01935, account denominated in USD:

Pipe value = (0.0001 / 1 01935) x 100,000

= 10.1935 CAD / pip / a standard lot

= 10.1935 / 1.01935

= $10 / pip for a standard lot size

= ($1 for a mini lot or $0.10 for a micro lot)

How to Calculate a Forex Position Size

Pips can be used to calculate the forex position size. As a trader, it’s essential to be able to correctly determine your position size since it’s an important part of proper risk management. Position sizing will help you maximize your gains but also considerably reduce your losses. You need to follow these 4 steps to accurately determine your position size:

1. Determine the amount of capital you are willing to risk per trade.
2. Determine a stop-loss in pips.
3. Determine the lot size traded.
4. Use the following formula for calculating the position size using pips:

Position size = capital per trade / ( stop-loss in pips x lot size)

For instance, if a trader risks 1% of his $5,000 balance per trade for a micro lot ($0.10 per pip movement) while fixing his stop-loss to 50 pips, the calculation would go as follows:

Position size = $50 / (50 pips x $0.10) = 10 micro lots

How to Calculate Forex Price Moves

Now that you are familiar with the concept of a pip and its use, we can jump into the notion of price moves and learn how much money you can gain or lose for each movement. Keep in mind the position size strongly influences this, since a larger position will have a greater consequence on your total balance with the same price movement in pips. Here is the formula for calculating forex price moves:

Monetary value of a pip = Position size x pip size

Let’s look at a quick example with EUR/USD. You open a position size of 10,000 units and calculate the pip value as follows:

Monetary value of pip = 10,000 (units) x 0.0001 (one pip) = $1 per pip

You will have noticed that pips are an essential part of a trader’s work. Indeed, they are vital to determine not only your position size and price moves, but also more basically for fixing your stop-losses. Moreover, the pip value may be one of the most important concepts a trader needs to learn in order to see clearly into his trades and therefore be profitable. A pip is a highly important unit of measure you absolutely need to take into consideration in your risk management strategy. Please, do not hesitate to read these concepts several times to immerse yourself in their meaning and be perfectly comfortable using them in your daily trading.