While trading on the forex trading floor, one is bound to come across dialogues like:
“I made a 25 pip profit on my trade” or “I lost around 123 pips in the market crash.”
So, what are forex pips and what does their value represent in the forex world?
“I made a 25 pip profit on my trade” or “I lost around 123 pips in the market crash.”
So, what are forex pips and what does their value represent in the forex world?
Definition of Forex Pips
Pip is the short form for Percentage in Point. It is used to represent the smallest value of measurement for currencies being traded in the forex market. Almost all major currencies in the world are measured only up to two decimal places, although, in forex, the calculations are done till the fourth decimal place. (The only exception being the Japanese Yen, which is only calculated up to two decimal places.) Therefore, the smallest move that can be made by a pip is .0001, which is commonly referred to as 1 basis point.
Calculating Forex Pip Values
The value of forex pips changes with fluctuations in the market. However, calculating them is not very difficult. For example, let us look at the pip calculations for the USD as both base and quote currency:
USD as the Base Currency: The formula here is simple: 1 Pip = 0.0001/exchange rate
Therefore, if one buys the standard lot of 100,000 pairs for USD/CHF and the exchange rate is 1.2490, then the pip value will be 0.0000800640 and equivalent forex pip value will be 8.0064
USD as the Quote Price: The pip value is always one.
Trading with Forex Pips and Leverages
The currency fluctuations in the forex market only bring about minute changes in the currency values. Like in the above example for the USD/CHF pair, the value of 1 pip is very small. So how do the big traders make millions on such small pips?
The answer lies in leverages. Forex brokers allow traders to deal with leverages as high as 100:1 or 500:1. This implies that in order to buy a standard lot of $100,000, the trader will have to deposit only $500 with a broker offering leverage of 200:1.
Let’s see the difference that leverages can bring about in a trade:
If the USD/CHF currency pair is worth 1.1535, then:
On investing $1,000 without leverage:
Profit = (.0001 / 1.1535) x 1000 = 0.0867
On investing $1,000 with 100:1 leverage:
Profit = (.0001 / 1.1535) x 100000 = 8.6692
However, trading through leverages is considered risky, as it amplifies the volume of both profit and loss.
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