Percentage in Point (PIP)

What is a PIP in Forex Trading?

In forex, price movements are measured down to the smallest decimal point. For most currency pairs, this is typically four decimal places. A single pip, in this case, represents a price change of 0.0001. For example, if GBP/USD moves from 1.4000 to 1.4001, that’s a one-pip change. However, for currency pairs that involve the Japanese yen (JPY), a pip is a movement of 0.01 since they are quoted to two decimal places.

Pips allow traders to gauge how much a currency's price has changed, and these fluctuations can lead to potential profits or losses.

Pips vs. Pipettes

For an even more precise view of the market, some platforms show price movements in fractional pips, or "pipettes," which are quoted to five decimal places. In such cases, the fourth decimal place is a pip, while the fifth decimal place is a pipette (one-tenth of a pip).

For example:

• EUR/USD = 1.60731
• 0.0001 represents the pip
• 0.00001 represents the pipette

How Pips Work in Forex Trading?

Let’s say a trader opens a long position on GBP/USD at 1.5000, and it moves to 1.5040. That’s a gain of 40 pips, which could result in a profit if the trade is closed. On the other hand, if GBP/USD falls to 1.4960, the trader would be down 40 pips, potentially leading to a loss. Pips play a vital role in helping traders assess their potential profits, losses, and risk levels.

Managing Risk with Pips

Pips are also essential for managing risk. Traders often set stop-loss orders, which close their position if the currency moves against them by a certain number of pips. This helps protect against larger losses.

For example, if you go long on EUR/USD at 1.3600 and set a stop-loss at 1.3550, you’re limiting your risk to 50 pips.

Calculating Position Size Using Pips

To avoid wiping out your capital, position size is crucial. Here’s how you can calculate it:

1. Determine Risk Per Trade: Let’s say you’re willing to risk 1% of your $5,000 account on each trade—this equals $50.
2. Set a Stop-Loss: If you set a stop-loss of 50 pips, then each pip movement will impact your trade by $1 per pip in a mini lot or $0.10 in a micro lot.

For a micro lot, you would divide $50 by 50 pips and $0.10 per pip movement, which equals 10 micro lots (or $1,000 position size).

Pip Value and Profit/Loss Calculation

The value of a pip depends on the currency pair and the size of your trade. Here’s a simple formula to calculate pip value:

Pip Value = (0.0001 × Trade Amount) / Spot Price

For example, if you have a $100,000 trade on USD/CAD at a rate of 1.0548 and the price moves to 1.0568, that’s a profit of 20 pips. The pip value would be about $9.46, and your profit would be 20 × $9.46 = $189.20.

What Causes Pip Values to Change?

Pip values usually remain constant for major currency pairs, particularly those involving the US dollar. However, if USD strengthens or weakens significantly (by more than 10%), pip values may change, especially for pairs where USD is the base or not involved at all.

Summary

Pips are fundamental to understanding profits, losses, and risk management in forex trading. By mastering the concept of pips, traders can better calculate their position sizes, set stop-losses, and make more informed trading decisions.