Forex trading has become the new in thing. If you are active on social media, you have probably come across the many ads promoting forex trading platforms and brokers.
You will hear forex traders talking about things like pips, spread, lots, and stop-loss orders, among many others. Here, our focus is on pips. This article will go down the rabbit hole to ensure you understand what they are, why they matter, and how they can affect your trading decisions.
Forex Pips 101
This could probably be your search query on Google. Pip is short for “price interest point” or “percentage in point.” What are pips in forex? For better visualization, it is the tiniest price movement a currency pair can make.
Usually, pips are measured to the fourth decimal place for most currency pairs. However, there are exceptions. For instance, the value of a pip in Japanese yen pairs is measured to the second decimal place.
An easy example to picture this is if the USD/JPY moves from 146.47 to 146.48, that is one pip rise. But if you are trading EUR/USD, a shift from 1.1050 to 1.1051 also marks an increase by one pip.
How Are Forex Pips Calculated?
This is where it gets exciting. Pip values depend on three things: the currency pair, the lot size, and the exchange rate.
The basic formula for most currency pairs — measured to the fourth decimal pair — is 1 pip = 0.0001 × lot size. So, if your trade size is 100,000 EUR/USD, you will get 0.0001 × 100,000 = $10 per pip.
The value of a single pip will change for currency pairs like USD/JPY. In such instances, the exchange rate will come into play. The upside is you can use the free pip calculators available on popular broker platforms like Weltrade.
Why Do They Matter?
From a layman’s point of view, forex pips can come off as of little value. Someone may ask what difference a price change of 0.0001 makes.
- Weighing Profit and Loss
It is the best way of measuring profit or loss in your forex trades. For example, if you buy USD/JPY at 146.30 and it rises to 146.50, you have gained 20 pips. On the other hand, if you buy the same currency pair at 146.50 and sell at 146.10, you have lost 40 pips.
- Risk Control
Forex experts use pips to calculate risks and rewards. You can use pips to set your stop-loss and take-profit levels. For example, if you are willing to take a 20-pip hit, you can set your stop-loss point 20 pips away from your entry price.
- Comparing Volatility
One thing you must know is that some currency pairs are highly volatile. Highly volatile currency pairs can shift by up to 40–50 pips. This information will help you choose currency pairs that align well with your trading strategy.
If you go by a high-risk, high-reward trading strategy, you will trade currencies with high volatility.
Final Thoughts
You can think of a forex pip as the heartbeat of forex trading. Even though they are small, their joint effect can make or break your trades. Learning the meaning of pips in forex trading and how to use pips in forex trading will help you refine your strategy and wade through the volatile waters in confidence.
