PIP is a term that is used commonly in trading. When you are just starting out in the business of trading currency, it is important to understand this term as it will come up frequently when it comes to forex trading.
PIP stands for Point in Percentage and is a small measure of change in a currency pair on the market. It is a standardized unit and is the smallest amount that a currency quote is able to change. It is used to help calculate profits and losses.
Understanding the PIP
When trading US dollar-related currency pairs, the PIP is usually 0.0001, known as 1/100th or 1%.
In other words, the PIP is usually the final decimal place in a quotation. Most pairs are listed up to 4 decimal points (although there are exceptions such as the Japanese yen that go to 2 decimal points).
Here is an example to help us understand:
When looking at a USD/EUR currency pair with a direct quote of 0.7747, we understand that for every US$1, we can buy 0.7747 euros. But, a one-pip increase in this quote would give us 0.7748 so that the value of the US dollar would be more compared to the euro and with US$1 you would now be able to buy slightly more euros.
The impact that a one-pip change has on US dollars will depend on the number of euros you have purchased.
Using the above example, if a person buys 10,000 euros with US dollars, they will have spent US$12,908.22 (1/0.7747*10,000). If there is then a one-pip rise in the exchange rate for the pair, those same euros will be worth US$12,906.56 (1/0.7748*10,000).
The pip value of that lot is US$1.66 (the difference between the initial and final value).
However, if the same person had bought 100,000 euros with US dollars, the same one-pip increase would result in a pip value of US$16.60.
Here we can see how the pip value is impacted by the purchase amount of the specific currency. In addition, because each currency has its own value, the value of a pip for every currency pair will be unique and will need to be calculated.
Pipettes in Forex Trading
There is also a concept known as pipettes that some brokers use. These are fractional pips. These brokers, instead of quoting currency pairs to 4 (or 2) decimal points, quote currency pairs to 5 (or 3) decimal points. In this case, using the example of the GBP/USD currency pair, if it moves from 1.30543 to 1.30544, it will have moved 1 pipette.
Why PIP Value is Important
Pip value affects risk, which means that if you don’t know what the pip value is, you can’t work out the ideal forex position size for a particular trade.
This may result in you risking too much or too little. In other words, to be able to trade successfully, you must know the pip value for the currency pair.