You asked yourself: What exactly is a pip? And why did he quantify his profits in pips? Don’t worry: this article will expand your knowledge of pips!
What is a Pip in Forex?
A pip is an abbreviation for “point in percent” and represents the smallest unit of change in the value of a currency pair. For most currencies, especially the majors, a pip represents the fourth decimal place in the exchange rate for the two currencies. However, this decimal place can be used for some currency pairs vary. For currency pairs with JPY, a pip is represented by the second decimal place.
Let’s take an example. Let’s say you are a trader trading EUR / USD. You opened a long position when the exchange rate was 1.4724. You predicted the price would go up and after a few minutes the price would go up to 1.4727 and you decided to close your trade. The price change here is 0.0003, which corresponds to 3 pip.
Let’s take a look at a real market situation. Let’s say you opened a long position when the price was 1.1259. You predicted that the price would go up, but the price is actually going in the opposite direction. Now you decide to close the position when the exchange rate is 1.1254. How much did you lose You have lost the entire change in value of the currency pair – 0.0005 – which is 5 pips.
What is a Pipette?
Most trading platforms use pips as the smallest units of measure for the change in the value of a currency pair. However, the need for more accuracy has led to the introduction of a pipette that is 1/10 of a pip. In this case, a pipette is represented by the fifth decimal place on your trading platform. If JPY is involved in the currency pair, a dropper is represented by the third decimal place.
Let’s use the previous example, but this time with a broker platform that allows the use of pipettes.
In this example, you opened a long position when the exchange rate was 1.12597. You expected the price to go up. Unfortunately, that was not the case. Instead, the price moved against your position. Now you decide to close your trade at 1.12542. In the end you lose 0.00055, which corresponds to 55 pipettes. I know that after looking at this example, you will appreciate the accuracy that pipettes offer. Pipettes offer dealers a higher level of accuracy than pips. In the previous example, the loss was 5 pips. But now we get a clearer picture with the more detailed unit of measure: 55 pipettes (5.5 pips).
Value of Pips
A pip value can be defined as the price associated with a pip movement in the foreign exchange market. If you are long and the price moves in your favor, your open trade will gain in value. The open position behaves similarly if the price moves against you. The pip value indicates how much the additional profit is worth. To get this value, we need to calculate the pip value.
Since the value of a pip is very low, Forex is always traded in standard lots, mini lots and micro lots. A standard lot consists of 100,000 units of the base currency. A mini pilot consists of 10,000 units, while a micro pilot consists of 1,000 units of the base currency. We also have a nano lot that is 100 units of the base currency. Below is a list of how the different lot sizes affect the value of a pip.
Lot size Units of the base currency Volume pip value in USD 1 Standard lot 100,000 1.0 1 pip = 10 USD 1 mini lots 10,000 0.1 1 pip = 1 USD 1 micro lot 1,000 0.01 1 pip = 0.1 USD 1 nanolos 100 0.001 1 Pip = $ 0.01
Changes in Pip Value
In most cases, the base currency of your account determines the pip value of the different currency pairs. If your account is in USD and the currency is USD as the listed currency (the currency that comes second in the currency pair), e.g. B. EUR / USD, the pip value is determined as explained above. In such a case, a standard lot has a pip value of $ 10. A mini-lot has a pip value of $ 1. and a microlos has a pip value of $ 0.1.
A change in pip value only occurs when the exchange rate of the US dollar moves more than 10% while the USD is the base currency (e.g. USD / CAD or USD / JPY) or the USD is not in the currency pair included (for example GBP / JPY). The account is in USD.
A good example is when the USD / JPY exchange rate fell from around 120 to a low of around 77 between 2008 and 2011. The rapid appreciation of the yen caused the pip value for the currency pair to change. In this case, the market movements had a significantly greater impact on the value as the pip value rose.
Now, based on the insights gained, let’s see what effect the change had on the pair’s pip value. The exchange rate in this case moved from 120 to 77. Prior to 2008, the standard lot pip value of USD / JPY in a USD account was $ 10/120 * 100 = $ 8,333. By 2011 the exchange rate had moved to 77 and the pip value had risen to USD 10/77 * 100 = 12.98 in the reporting period. Therefore, market movements had a greater impact on value.
Calculation of the pip value and the position size
As we have already described, the pip value shows how much a pip movement contributes to your profit or loss. Pip value is important because it helps you manage risk. For example, if you don’t understand the pip value, how can you calculate the ideal position size? If you don’t understand the concept of pip value, it will be difficult for you as a trader to measure and control your risk.
Let’s say you have a euro trading account and want to trade 1 standard lot EUR / USD at an exchange rate of 1.20. In the case of EUR / USD, 1 pip corresponds to 0.0001.
Pip value = 0.0001 / 1.20 * 100,000 = 8.333 euros
Pip value for accounts denominated in USD
Many trading accounts are in US dollars. Whenever the USD ranks second in a currency pair and the account is denominated in US dollars, the pip value does not change.
In such a case, a standard lot has a pip value of $ 10. A mini-lot has a pip value of $ 1. and a microlos has a pip value of $ 0.1. This applies to any currency pair as long as the USD is in second place. Here are some examples: EUR / USD, AUD / USD, GBP / USD, NZD / USD.
If the USD is the base currency (listed first in the currency pair), just use the formula above. Suppose you are trading a standard lot of the USD / CAD currency pair. In this case, as you can see, the USD is listed first. Assuming that the USD / CAD exchange rate is 1.25, the pip value in US dollars would be 10 / 1.25 = 8 USD. Below you can see how to calculate the pip value for mini lots and micro lots.
Pip value for standard lots = 10 / (USD / XXX)
Pip value for mini lots = 1 / (USD / XXX)
Pip value for microlose = 0.1 / (USD / XXX)
Pip value for accounts not denominated in USD
Let’s say you have an account in Canadian dollars. Every time you trade a currency pair with the second-highest Canadian dollar, the pip value remains fixed. In such a case, a standard lot has a pip value of 10 CAD; A mini-lot has a pip value of CAD $ 1; and a microlos has a pip value of 0.1 CAD.
What happens if the Canadian dollar is listed first, as in the case of CAD / CHF? You get the pip value by dividing the fixed prices by the exchange rate from above. Let’s say the CAD / CHF exchange rate is 0.8. What is the pip value for a micro lot? It will be CAD $ 0.1 / 0.8 = CAD $ 0.125. You can do the same for standard and mini tickets.
Pip value for standard lots = 10 / (CAD / XXX)
Pip value for mini lots = 1 / (CAD / XXX)
Pip value for microlose = 0.1 / (CAD / XXX)
What if the currency pair now has CAD as the base currency and JPY as the quoted currency (CAD / JPY)? Let us show an example: Suppose the exchange rate for CAD / JPY is 90.00. In this case, what would be the pip value for a standard lot?
We’ll use the formula discussed above, but then multiply the result by 100.
Pip value for 1 standard lot CAD / JPY = 10 / (CAD / XXX) * 100
10/90 * 10 = CAD $ 11.11
You can use this process for other currencies like EUR or even the Australian dollar.
The pip value for other currency pairs
You may have an account in USD, but you are trading in a currency pair that does not include the US dollar. You may have a USD account, but you have chosen to trade in a currency pair such as EUR / CHF or EUR / GBP.
Let’s take the example of EUR / CHF. The established rule is: If you have an account denominated in CHF and trade EUR / CHF, the pip value is fixed (CHF 10 for standard tickets, CHF 1 for mini tickets and CHF 0.1 for micro tickets).
In this case, we assume that we calculate the pip value for a standard lot that is set at CHF 10. So if my account was in USD, I would get my pip value by dividing CHF 10 / (USD / CHF). This is the fixed value divided by the USD / CHF exchange rate. For example, if the USD / CHF exchange rate was 0.80, the pip value would be 10 / 0.80 = USD 12.50.
What would happen if you couldn’t find the USD / CHF rate and instead could find the CHF / USD rate? What would you do in this situation?
You must use the CHF / USD inverse rate to get the USD / CHF rate. Assume that you have found that the CHF / USD exchange rate is 1.25. In this case the inverse rate would be 1 / 1.25 = 0.80.
The relevance of pip values in hedging
The hedge involves buying and selling securities at the same time to reduce risk. Many traders see this as a risk-free position, since losses are offset by profits on the one hand. However, this is not always the case. The hedge involves some risk, as wide spreads can flow into both positions, which can lead to losses.
Spreads widen mainly in times of important global events, for example, when the Swiss National Bank scrapped the upper limit of CHF 1.20 per euro in 2015. Brexit is another major global event that can affect your secured business.
At such times, the spread depends entirely on offers and requirements. The spread can even be 100 pips wide. If this is the case for both positions, the results can be devastating. If the currency pairs involved are illiquid, the spreads should be even larger, which would lead to further losses for the hedged position.
As you read this article, you should now understand that a pip is the smallest unit of price change that is measurable for a currency pair. You now know about the crucial role that pip value plays in retail. You don’t have to calculate the pip value yourself during your actual trading as there are some calculators that do this job for you. To learn more, you should register a demo account so you can see how the pip value affects your winnings.
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