If you are interested in forex trading or CFD trading, you have undoubtedly come across the term pip or pips, as this is common trading terminology. In this article, we explain what pips are, how big pips can be, and how to use pips to calculate price changes.
What are pips?
A pip is a change in price by a value specific to the market concerned. It is a standard unit for measuring how much a market’s price has changed.
The original definition of a pip was, in a sense, “the smallest unit by which a value’s price can change.” However, with the more precise methods of price measurement of our time, this explanation is no longer really applicable.
Traditionally, prices were quoted to a specified number of decimal places – usually four – and a pip, by this now obsolete definition, was a price movement of one point of the last decimal place listed. Many brokers now quote the prices of their instruments to five decimal places, which means that a pip is only sometimes the last decimal place in a quote.
Pips continue to be a standardized unit across all brokers and platforms, making them very useful in measuring values from different sources and between different traders in a consistent manner, avoiding confusion. Without such a standardized unit, traders would be literally comparing apples to oranges when it comes to everyday issues like points or ticks.
What does pip mean?
Some claim that the term pip originally came from percentage-in-point, but this is probably a common misconception. Others assume Pip stands for Price Interest Point.
Despite its unclear origin, the pip allows the trader to discuss price developments with other traders and draw on a standard basis of values. The basis point (Bip for short) is similar, except that it refers to smaller and, therefore, more precise values.
That answers the purpose of pips – it’s a lot easier to talk about 55 pips than having to resort to the cumbersome phrase “0.0055” when discussing price action.
How big are pips?
For most currency pairs, a pip describes a movement of the fourth decimal place. The most notable exception are FX pairs involving the Japanese Yen – in which a pip is commonly a movement of two decimal places.
If you multiply your position size by a pip, you can calculate the value of a pip. Suppose you are trading EUR/USD and decide to buy a lot. One lot is worth $100,000. One pip describes a size of 0.0001 for EUR/USD – so the value of a one pip move is 100,000 x 0.0001 = $10.
If you now buy a lot in EUR/USD at a fictitious exchange rate of 1.6650 and later sell the position at 1.6660, the exchange rate difference is calculated as follows:
1.16660 – 1.16650 = 0.00010
In other words, you achieve a profit of 1 pip. This one is worth $10, as we’ve seen before. If we revisit this example from a different angle, it becomes clearer what constitutes a pip in trading.
This is how forex pips work
So you opened a position at 1.16650 and bought a contract. You effectively bought 100,000 euros. You nominally sold dollars to buy euros. The value of the dollar you notionally sell is determined by the exchange rate.
EUR 100,000 x 1.16650 USD/EUR = USD 116,650
You then closed your position at 1.6660. Here, nominally, the opposite of the transaction before happens – you sell euros to buy dollars.
EUR 100,000 x 1.16660 USD/EUR = USD 116,660
You sold $166,650 in this example, and by closing the trade again you got back $166,660 for a profit of $10. This illustrates that a one-pip price move is effectively worth $10.
This pip value can be applied across all FX pairs, which are quoted to four decimal places – a price movement of one pip is equivalent to a value of 10 units of the quote currency (i.e., the last-mentioned currency), assuming a position size of one lot (which always corresponds to 100,000 units of the base currency, i.e., the currency first mentioned).
Accordingly, a movement of 10 pips is worth 100 units of quote currency, a movement of 100 pips is worth 1,000 units of quote currency, and so on.
What about currencies that are not specified to four decimal places?
The most important example is the Japanese yen. Currency pairs that include the yen are traditionally quoted to two decimal places, and pips for such pairs also start from that place. Let’s look at an example calculation for the USD/JPY pair below to illustrate this.
If you sell 1 lot in USD/JPY, a 1 pip down move will make a profit of 1,000 yen.
Suppose you sell 2 lots in USD/JPY at a notional price of 113,607. Since one lot is worth $100,000 in USD/JPY, this order sells 2 x $100,000 to buy 2 x 100,000 x 113,607 = 22,721,400 yen.
Price is moving against you, and you close the position at 114.107 to minimize your losses. One pip in USD/JPY corresponds to a price movement of the second decimal place – the price has moved by 0.50, i.e., by 50 pips.
They closed the position of 2 lots in USD/JPY at 114,107. To buy back $200,000 at this rate, you need to spend 2 x 100,000 x 114,107 = 22,821,400 JPY. Since this is 100,000 JPY more than you originally spent in US dollars to open the position, you made a loss of 100,000 JPY.
Losing 100,000 JPY for a 50-pip move means you lost 100,000/50 = 2,000 JPY per pip. Since you held a position of 2 pip, that’s a pip value of 1,000 yen per lot.
Having your account denominated in a currency different from the base currency of a pair will also affect pip values.
Digression: terminology in CFD trading
If you are next to Forex and also want to trade CFDs on stocks, commodities, indices, bonds, or ETFs, then you might be wondering if there are pips in these markets as well. In fact, pips make little sense when dealing with markets such as the stock market, as there is already existing terminology for price changes in this case: pence and cents.
The whole numbers in the exchange rate represent the exchange rate in USD, and the decimal places are the corresponding cents. This system is intuitive and understandable, even for trading beginners.
Therefore, there was no need to include specialized terms such as pips for stocks – although the general term tick is sometimes used in market jargon to represent price movement by the smallest possible unit (1 cent in this case).