A pip (short for percentage in point) is a unit of measurement. It’s the smallest price movement that a market can make. Although these represent the smallest value, they play a big part in the world of trading.
So, what exactly is a pip?
An introduction to pips
Pips make it possible for traders to measure price changes and assess potential profits or losses. They’re a yardstick for gauging the volatility and momentum within a market. Whether you’re a novice trader or an experienced investor, understanding pips is essential for navigating the complexities of trading.
Pips are referred to across most markets, but they play a big role in forex trading. Most currency pairs are quoted to four decimal places and one pip represents the fourth decimal place change in the exchange rate. As an example, if the EUR/USD currency pair moves from 1.5500 to 1.5501, that’s classed as a one pip movement.
We do see pips in other markets, such as index trading. Indices are typically priced to one decimal place. So, if the FTSE 100 moved from 7882.8 to 7882.9, this is a movement of one pip.
Calculating pips
Calculating pips is relatively straightforward once you grasp the concept.
To calculate the value of a pip for a currency pair, you’ll need to consider the exchange rate and the position size (the number of units traded). For currency pairs quoted in the standard format (four decimal places), the formula for calculating pip value is as follows:
Pip value = (0.0001 / Exchange Rate) * Position Size
For example, if you’re trading 100,000 units, which is one standard lot of EUR/USD, at an exchange rate of 1.2500, the pip value works out as:
Pip value = (0.0001 / 1.2500) * 100,000 = $8.00
It’s important to note that pip values vary depending on the currency pair being traded and the size of the position. For currency pairs quoted in the Japanese yen (JPY), where the exchange rate is typically quoted to two decimal places, the calculation is slightly different.
Practical applications of pips
One practical application of pips is in setting stop-loss and take-profit levels. By incorporating pip-based analysis, traders can determine appropriate levels to limit potential losses and lock in profits. For example, if a trader sets a stop-loss order 50 pips below the entry price, they can mitigate the risk of significant losses if the market moves against their position.
Moreover, understanding pip movements allows traders to gauge market volatility and make informed decisions. Economic indicators, geopolitical events, and market sentiment can all influence pip movements.
For instance, positive economic data releases may lead to an increase in the value of a currency, resulting in upward pip movements. Conversely, geopolitical tensions or adverse news events can trigger volatility and downward pip movements.