Definition: The term Pip is the abbreviation in English for “point in percentage” or percentage point. It is a measure of the smallest movement of the exchange rate in a currency pair on Forex. A pip is a standardized unit and is the smallest amount by which a currency price can change.
For most pairs, one pip is the equivalent of a 0.01% change or 1/100 of one percent. This value is generally called, in financial terminology, base point. (BPS). A base point, therefore, is equal to 1 / 100th of 1% or, what is the same, 0.01%. This percentage, in absolute terms, is equal to 0.0001.
This standardized size helps protect investors from the greater losses that a larger unit of variance would cause. For example, if the minimum point of change were equal to 10 basis points, a change of one point would cause greater volatility in currency exchange rates and, therefore, greater risk.
This is one of the reasons that has contributed to FOREX trading becoming so popular in recent years.
So, broadly speaking, one pip corresponds to $ 0.0001 for currency pairs related to the US dollar:
If, for example, the exchange rate of the EUR / USD pair appreciates from a value of 1.1850 to 1.1851, the movement of $ 0.0001 USD is one pip. In this case it would be said, therefore, that the pair has appreciated a pip.
The exchange rate of most currency pairs has 4 decimal places. However, there are some exceptions such as pairs based on the Japanese yen, whose variation is measured to 2 decimal places.
For example, the exchange rate of the EUR / JPY pair is quoted to two decimal places. In this case, if the pair appreciates from a value of 110.75 to 110.76, this movement of 0.01 is a variation of one pip.
You can also find the price of currency pairs to one more decimal place. In these cases the price of the pairs with 4 decimal places would have 5 and the price of the pairs with 2 decimal places would have 3 decimal places.
This last decimal measures the variation of the price in fractions of pips, called “pipettes”.
In the above example, if the EUR / USD exchange rate appreciates from 1.18505 to 1.18506, this movement of $ 0.00001 USD is a pipette.
The way to show the variation in the price of a currency pair depends, ultimately, on the trading platform () and the currencies that make up the pair, so there are systems that show 4 or 2 decimal places (pips ) and others that show 5 or 3 decimal places (pipettes).
How to calculate pip value and position size?
In Forex there are countless currency pairs. As each currency pair has its own exchange rate, the calculation of the monetary value of a pip must be determined for each currency pair in a particular way. Below are two examples of this calculation for different currency pairs. The examples use the standard quote with 4 and 2 decimal places:
Example 1: EUR / USD = 1.1850
- The expression of this exchange rate is equivalent to saying that with 1 EUR I get 1.1850 USD.
- The monetary value of the pip is determined in terms of the base currency, which in this case is the EUR.
- To obtain this value, the following formula is used:
- (USD 0.0001) x (EUR 1 / USD 1.1850) = EUR 0.00008439 per unit traded.
Continuing with the example, if the volume traded is 10,000 units of the EUR / USD pair, then a variation of one pip in the price of the EUR / USD would mean, approximately, a variation of 0.84 EUR in the value of the position (10,000 units x 0.00008439 EUR / unit).
If the position were to buy and the movement of a pip were higher, the position would increase in value by the specified amount.
If, on the other hand, the position were to buy and the movement of a pip were to fall, the open position would decrease in value by the specified amount.
As can be seen, as the exchange rate of the pair changes, the monetary value of each movement of a pip also changes.
Example 2: USD / JPY = 110.75
- In this example, a currency pair is used in which the quoted currency is the Japanese yen and the base currency is the US dollar.
- Unlike the previous example, the variation of 1 pip in the exchange rate is measured with the second decimal place. Therefore the movement of a pip is equivalent to 0.01 JPY.
- To obtain the monetary value of 1 pip, use the same formula as the first example adapted to this currency pair:
- (0.01 JPY) x (1 USD / 110.75 JPY) = 0.0000903 USD per unit traded.
In this case, if the volume traded is 10,000 units of the USD / JPY pair, then a change of one pip in the price of USD / JPY would mean, approximately, a change of 0.90 EUR in the value of the position (10,000 units x 0.0000903 EUR / unit).
If the position were to sell and the movement of a pip went up, the position would decrease in value by the specified amount.
If, on the other hand, the position were to sell and the movement of a pip were to fall, the open position would increase in value by the specified amount.
In the same way as in the first example, as the exchange rate of the pair changes, the monetary value of each movement of a pip also changes.
As has been seen in the examples shown, the monetary effect of the variation of 1 pip in a FOREX account depends on the size of the positions that are open. The larger the size of these positions, the greater the economic impact of the 1 pip change in the economic value of the position.
In the past, in FOREX the size of positions was standardized in units called lots. The standard size of a lot is 100,000 units of a currency.
Today it is possible, however, to open positions with lots of much smaller size: 10,000, 1,000 or even 100 units.
As explained, the variation of 1 pip in the exchange rate of a currency pair affects the fourth or second decimal place, so it involves a very small variation in the value of the currency.
Therefore, for this variation to have a significant economic impact on the economic value of a position, FOREX trading orders will have to be of a certain size.
With this in mind, it is checked below how the issuance of orders with a standard lot size (100,000 units), instead of the 10,000 units previously considered, affects the examples shown.
Example 1: EUR / USD with an exchange rate of 1.1850:
(0.0001 / 1.1850) x 100,000 = 8.4 EUR for each pip.
Example 2: USD / JPY with an exchange rate of 110.75:
(0.01 / 110.75) x 100,000 = 9.4 USD for each pip
Pips, profit and loss calculation
Once it has been explained how to calculate the value of a pip, we will explain how the result of a FOREX operation is calculated from the economic value of a pip.
For this, the currency pair from the first example shown will be used.
In this case, the economic result of a purchase order for the EUR / USD pair with a size of 1 lot is analyzed. By placing a buy order on this pair, you are buying euros and selling dollars. Therefore, a trader will issue this buy order if he has an expectation that the euro will appreciate against the North American currency.
The steps of the operation are as follows:
- At the time of issuing the order, the EUR / USD pair is trading at 1.1850 / 1.1855. As the order is to buy, the asking price is applied: 1.1855.
- A few hours later the price of the pair moves higher and is trading at 1.1870 / 1.1875.
- At this time the purchase order is closed. As a buy order is being closed, it must be sold to close the position, so the price that applies is the bid price, which in this case is 1.1870.
- The difference between the selling price and the buying price is, therefore: 1.1870 – 1.1855 = 0.0015 or 15 pips.
- Using the formula explained in the previous point, the economic result of the operation can be calculated:
- (0.0001 / 1.1870) x 100,000 = 8.42 EUR for each pip
As the variation from the opening to the closing of the purchase order has been 15 pips, the economic result of the order is equal to:
8.42 EUR / pip x 15 pips = 126 EUR.
This is the gross result of the operation. To obtain the net result, it would be necessary to subtract the spread that represents the remuneration of the broker’s services.
