As you start trading in forex, there’s no doubt you’ve heard of pips getting thrown out every now and then. But as a beginner, we can’t blame you for finding it hard to make sense of all these confusing words.
But there’s nothing to worry about. We’ll help you to understand what you need to know about pips. It’s one of the most basic concepts that have hidden complexities that every trader must know.
What is a pip forex?
Pip is an acronym for “percentage in point” or “price interest point.” Traders often use pips to reference gains or losses in forex.
Let’s try to make it simpler. Pips represent the smallest movement that a currency pair can make. Usually, it is $0.0001 for US-dollar related currency pairs, which is referred to as 1/100th of 1%, or one basis point. Let’s say if a pip was 10 basis points, a one-pip change would cause greater volatility in currency values.
A pip measures the smallest price change of any currency can make. Most pips are equal to a 0.0001 price change.
If EUR/USD moves from 1.2278 to 1.2279, that 0.0001 USD rise in value is one pip.
However, there is an exception. Where a currency has a low unit value, the price is quoted to 2 decimal places. For instance, a pip is 0.01 instead of 0.0001. The best example for this is the USD/JPY pair. If the pair increases from 106.16 to 106.17, the rise of change is one pip.
The value of a pip
In every trade, there comes a risk. It’s important to know the pip value of each position in the currency of your account. This way, you can manage your risk more effectively.
Read more: Proper Risk Control When Forex Trading
Here’s how you can get the pip value.
(Pip in decimal places x Trade Size) / Market price = Pip Value
Imagine you’re trading EUR/USD with a trade size of 100,000 and the exchange rate at 1.13798.
(0.0001 x 100,000) / 1.13798 = 8.78750]
With this result, we can say that each pip is worth 8.79 euro.
Of course, you don’t have to calculate this yourself. Brokers can do this for you, or you can use forex pips calculator that are widely available on the internet.
Pips and Spreads
Every time a currency pair is quoted, there are two prices. The first is the bid price. This refers to how much is being offered for the currency pair. The second is the ask price, which refers to how much sellers are asking. Spread is the difference between the two, and measured in pips.
Buy orders are executed at the higher ask price, and sell orders are executed at the lower bid price. So, if you buy and then sell immediately, you will always lose the amount of spread.
That is why forex traders look for few spreads, since the spread is like a tax, except on a private one.
The money you lose on spreads will then go to the market maker or broker. This is how they make profits. This is also the reason why forex trading doesn’t involve commissions, since the broker’s profit is already built into each trade.
Pips are very useful in forex trading. Sometimes, you don’t have to calculate for the pip value, but it’s still worth knowing how to determine them. With that, you can utilize pips in different trading styles you can apply.
After reading this article, You can check out our article on How to be successful forex trader as your guide for a successful trading career.
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