A pip is one of the most important concepts in currency trading. This is used to work out your profit or loss. Traders often express their gains or losses in the number of pips that they have gained or lost. Given that profits or losses are the most important part of the trading, it suddenly becomes clear why pips are so important. Yet given its importance, it is surprising how many traders do not understand what a pip is.
Pip is actually an acronym for percentage per point. A pip is the smallest price change that an asset can make. In the forex markets, forex pairs are often quoted in four decimal places, so a 0.0001 change equals one pip. The Japanese Yen is a standout exception and it traded to two decimal places so 0.01 is equivalent to 1 pip.
For example, EUR/USD was trading at $1.2410, it then rose 50 pips to $1.2460.
The USD/JPY trades at 10540, it then rose 50 pips to 105.90.
Some forex brokers only trade to 4 decimal places (2 for JPY) however some show a quote with 5 decimal places to gives even more clarity to the price.
So now we know what a pip is, how does this relate back to how much we make or lose from a trade? Well this depends on the size of your stake. Larger positions mean that each pip movement that the currency pair experiences will have bigger monetary consequence.
To work this out, quite simply we multiply:
Position size x 0.0001 = monetary value of 1 pip
This will tell us how much we would make or lose per pip movement, regardless of the price.
For example, a position of 10,000 units in GBP/USD
10,000 X 0.0001 =1
This means that we would make or lose $1 for each point movement in the GBP/USD. Therefore, if GBP/USD moved 100 pips in my favour, I would make $100.
Should we do the same for different sized trades then:
5,000 x 0.0001 = $0.5 per pip movement
50,000 x 0.0001 = $5 per pip movement
Notice that the pip value will always be measured in the quote currency of the pair (the currency on the right-hand side). So, whilst GBP/USD always sees pip size in dollars, EUR/GBP will also see pip size in pounds sterling.
Before you place your trade, it is essential that you understand how large your trade is and what you are risking on your trade. In order to be able to work out these calculations you must be able to work out the per pip value. Once you know this, you can use the information to help you decide where you will put your stop loss and how much you will be risking. Remember you should only be looking at risk around 2% of the capital that you have available in your account.