Contrary to what you may have heard, size does matter! This is even more applicable to the world of forex trading. The size of everything matters. The size of the trade, the size of the position, and of course, the size of the change.
For the latter, we use a measurement known as pip, also called pip value or pip range. But does it actually mean? How can you calculate these pips for your position? And what is the special role of pips in forex trading? Let’s discuss all of these questions in this article together.
What Is the Definition of a Pip?
On its own a pip is the abbreviation of another longer phrase. A pip stands for percentage in points. Certain sources also claim that pip stands for price interest point.
In the foreign exchange market, each pip is equal to the smallest unit of change in prices. And the simple way that you can use to calculate the pips that occur for a currency pair is by looking at its full price.
The full price in forex is usually shown in four decimal digits. Naturally, we mentioned that each pip is the smallest change possible in the price of a currency pair in forex. And of course in the four decimal digits, the smallest number is the last one.
So, each change in the last and fourth decimal digit in the price represents one pip change. For example, if the price of a currency pair such as EUR/USD is 1.0912, then if the price goes from its current state to 1.0913 we can say that the price has gone up one pip – or its change is equal to one pip.
Pip changes are not usually meant to represent prices going up or down, although we will also discuss that shortly, but the main purpose of pips is to represent the degree or amount of change, in either direction.
What Is the Definition of Pipette?
There is another term that is usually thrown around alongside with pip, and that is pipette. There are enough similar terms in forex that can make traders a lot of confusion. But what is the meaning of a pipette? And how is it different from a pip?
A pipette is sort of the smaller unit of a change. So it is smaller than a pip. But how much smaller?
As mentioned above, a pip is equal to one digit change in the fourth decimal of the quoted price of a currency pair. And this price is normally quoted with four decimal places.
But there are brokers that quote the price of the currency pair to more decimal points. In that case we naturally need a smaller unit of measurement to calculate the change in prices.
When the price of a currency pair goes beyond the four digit decimals, that is when we need a pipette to measure change.
A pip is ten times larger than a pipette. In other words, a pipette is one tenth of a pip. Naturally, that would mean if the pip is the fourth decimal digit, then a pipette would be ten times smaller which makes it the fifth decimal digit.
Let’s look at pip and pipette together in an example. For the following examples we are going to mention the amount of change in terms of pips or pipettes, whichever fits the situation better.
EUR/USD = 1.0912 goes to 1.0913 / price change = 1 pip
EUR/USD = 1.0912 goes to 1.0932 / price change = 10 pips
EUR/USD = 1.09123 goes to 1.09124 / price change = 1 pipette
So as you can see a pipette is just a smaller unit of measurement for change in prices. That is why a pipette is also regarded as a fractional pip.
How Can You Calculate Pip Value?
So how does pip come into play in calculating your profit from a trade? The thing you need to know about pips is that pip range is directly tied to the profit from your trades.
In fact, you need to know the exact pip value in order to calculate the amount of profit you can make from your trade or your position.
So, again let’s go back to the example of Euro against the United States dollar, which is the most traded currency in the forex market.
Imagine you enter a position with this pair at the price of 1.0912 for the quoted price of the currency. So for EUR/USD this means that for each unit of the base currency which is the Euro, you would need to pay 1.0912 of the second currency or the quoted currency which is the US dollar in this case.
So in this case the pip changes that occur in price can be calculated in terms of the US dollar. Please keep in mind that this is not always the case. This depends totally on the currency pair you are trading. Naturally, the quoted price of the currency pair depends on the quote currency which is the second currency in the pair.
But for reasons of simplicity we have chosen a pair with the US dollar as its second currency.
Alright, let’s get back to our position with EUR/USD at $1.0912. Further suppose that the price of the currency moves to $1.0913. Obviously, the pair has experienced one pip change.
So how much would you profit from this one pip change toward the positive side? The answer to that question is totally dependent upon the size of the position. Otherwise known as the lot size, this number can also vary greatly depending on the trader and also the broker.
As you know the standard lot size in the forex market is 100,000 unit of the base currency. But since that is usually a high number for most traders, there are other smaller lot sizes.
For the purpose of this example, let’s suppose our lot size for this position is 10,000.
So if the price of the pair goes from $1.0912 to $1.0913, your profit from this change would be one pip times 10,000. In other words, you need to multiply 10,000 with 0.0001. luckily because of the pair we have chosen, the pip value can also be calculated in terms of dollar value – i.e. 10,000 * $0.0001 = $1
This amount is the pip value for this particular position. So for this position each pip is equal to one dollar.
Using Pip Value to Calculate Profits
Building on our previous example of EUR/USD, we found that for a position size or lot size of 10,000 the pip value would be equal to 1 dollar.
Alright, let’s calculate the final profits from this position. That is the easy part. You just get all the pips that occur in the quoted price and multiply that by the pip value you have already obtained.
So if you entered the position at $1.0912 and the price went to $1.0916, you profit from this position would be equal to:
1.0916 – 1.0912 = 0.0004 = 4 pips * $1 = $4
Conclusion
Pip is the smallest unit of change in the price of a currency pair in the forex market. The prices of currency pairs are usually quoted up to 4 decimal points. Therefore, each single change in the last decimal digit of the currency pair is equal to one pip.
