What Is a Pip?

A "pip" is an acronym for percentage in point or price interest point. In the context of the foreign exchange market (forex), a pip is the smallest whole unit price move that an exchange rate can make. Most currency pairs are priced out to four decimal places, and a single pip is represented in the fourth decimal place (i.e., 1/10,000th). For instance, in the USD/CAD currency pair, the smallest whole unit move is $0.0001, which is equivalent to one pip.

Pips in forex trading should not be confused with basis points (bps) used in interest rate markets, where one basis point represents 1/100th of 1% (i.e., 0.01%).

KEY TAKEAWAYS

• Forex currency pairs are quoted in terms of pips, short for percentage in points.

• In practical terms, a pip is one-hundredth of one percent (1/100 x 0.01) and appears in the fourth decimal place (0.0001).

• It is the smallest price change increment for most forex pairs.

• The bid-ask spread of a forex quote is typically measured in pips.

Understanding Pips

Pips are a fundamental concept in foreign exchange (forex) trading. Forex traders engage in the buying and selling of currency pairs where the value of one currency is expressed concerning another. The quotes for these currency pairs are displayed as bid and ask spreads, accurate to four decimal places. The movement in the exchange rate between these pairs is measured in pips. Since most currency pairs are quoted with a maximum of four decimal places, one pip is the smallest whole unit change for these pairs.

Calculating Pip Value

The value of a pip varies depending on the currency pair, the exchange rate, and the trade value. When your forex account is funded with U.S. dollars and the USD is the second currency in the pair (the quote currency), such as in the EUR/USD pair, the pip is fixed at 0.0001. In this case, you can calculate the pip value by multiplying the trade value (or lot size) by 0.0001. For example, for the EUR/USD pair, if you trade 10,000 euros, the pip value is $1. Therefore, a movement from 1.0801 to 1.0811 in the EUR/USD pair would result in a profit of 10 pips, or $10.

However, when the USD is the first currency in the pair (the base currency), as in the USD/CAD pair, the pip value takes the exchange rate into account. To calculate the pip value in this case, divide 0.0001 by the USD/CAD exchange rate and then multiply it by the lot size. For instance, with an exchange rate of 1.2829 and a standard lot size of 100,000, the pip value is $7.79. If you traded 100,000 USD against the Canadian dollar at 1.2829 and closed the trade at 1.2830, you'd make a profit of 1 pip, which is $7.79.

JPY Exception

Japanese yen (JPY) pairs are an exception to the four decimal place rule. These pairs are quoted with two decimal places. To calculate the pip value for JPY pairs, divide 1/100 by the exchange rate. For example, if the EUR/JPY is quoted as 132.62, one pip is equal to 1/100 ÷ 132.62, which equals 0.0000754. If you traded a lot size of 100,000 euros in this pair, the value of one pip (in USD) would be $7.54.

Additionally, fractional pips, often referred to as "pipettes," are used for more precise measurements. These represent 1/10 of a pip and are denoted as a superscript numeral at the end of a quoted exchange rate.

Pips and Profitability

The movement in the exchange rate of a currency pair determines whether a trader makes a profit or incurs a loss. When you buy a currency pair, such as the EUR/USD, you profit when the euro strengthens in value relative to the U.S. dollar. If you bought the euro at 1.1835 and sold it at 1.1901, you would make a profit of 66 pips (1.1901 - 1.1835).

For the USD/JPY pair, a trader who sold the pair at 112.06 and closed it at 112.09 would incur a loss of 3 pips. If the trade was closed at 112.01, the trader would make a profit of 5 pips. These seemingly small differences in pip movements can add up quickly, especially in the vast foreign exchange market, affecting the overall profitability of a trade.

Real-World Examples of Pip

Extreme cases of hyperinflation and devaluation can lead to exchange rates becoming unwieldy. An example of this occurred in Germany's Weimar Republic when the exchange rate collapsed from 4.2 marks per dollar before World War I to 4.2 trillion marks per dollar in November 1923. This made trading nearly impossible, and the concept of a pip became almost irrelevant.

Another example is the Turkish lira, which reached a rate of 1.6 million per dollar in 2001, rendering many trading systems incompatible. The government responded by removing six zeros from the exchange rate and renaming it the "new Turkish lira." In January 2021, the average exchange rate stood at a more reasonable 7.3 lira per dollar.

In conclusion, a pip is a fundamental concept in the forex market, representing the smallest price movement of a currency pair. It serves as a critical basis for trading decisions and allows traders to quantify potential gains or losses. Understanding pips is essential for effective risk management and profit calculations in the forex market.

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