The term “pips” is the plural of “pip”. A pip in trading is the whole unit of measurement for price change in currency pairs.”
PIP = Percentage in Point
Price conventionally has 2 decimal points. So 1% of the price is the 4th decimal point. Except for a few JPY pairs, the 4th decimal represents the units of pips.
A pipette is 1/10 of a pip in value, which means it is the 5th decimal. Almost all modern forex brokers provide prices up to the 5th decimal or the pipette.
1 pip = 0.01% of the quoted value (4th decimal) Consider the following EURUSD buy trade: Trade open price = 1.03362 Trade close price = 1.03997 Total pips gained from the trade = 1.0399 - 1.0336 = 63 pips Precisely 63 pips and 5 pipettes.
In case you are wondering, this website is named “Trade Pips”, because essentially this is all what forex traders do – trade currencies to gain pips.
Before we can go onto the method of calculating the value of 1 pip, we have to know the concept of “Lot size” in trading.
Standard, mini, micro, and nano lots
Lot is the denomination for the size of the trade. Standard – as the word suggests is the standard lot size. In the old days, forex brokers provided 3 typical lot sizes – standard, mini, and micro.
Later on, the nano lot size was added to the commonly-provided list. Nowadays, you can even trade non-conventional lot sizes.
Many forex brokers use the range of lot sizes they provide as a value-added feature to capture new clients.
From standard to nano, the lot size gets reduced to 1/10 of its closest higher adjacent value. 1 standard lot size equals 100,000 units of the base currency.
Following is the breakdown of typical lot sizes:
|1 Standard lot||100,000|
|1 mini lot||10,000|
|1 micro lot||1000|
|1 nano lot||100|
Calculating the Value of a PIP
The value of a pip changes depending on the base currency and the trade size (number of lots).
for EURUSD 1 standard LOT = 100,000 USD's worth
We can calculate the value of 1 Pip in the following manner:
Assuming the EURUSD price @ 1.0336:
100,000 USD @ 1.0336 1 EURUSD standard lot value = ( 100,000 / 1.0336 ) EUR 0.0001 EURUSD (pip) value = ( 10 /1.0336 ) EUR 0.0001 (1 pip) value = 9.67 EUR 0.0001 (1 pip) value = 9.67 x 1.0336 = 9.995 USD
Let’s do the same calculation where the USD is the quote currency.
Assuming the USDJPY price @ 135.93
100,000 JPY @ 135.93 1 USDJPY = ( 100,000 / 135.93 ) USD 0.01 USDJPY (1 pip) value = 1000 / 135.93 = 7.356 USD
Margin account and leverage
If you need to open 1 standard-lot-trade on the EURUSD pair, you will need (as per the example above) 96,749.23 USD. The average retail trader doesn’t have the capacity to hold hundreds of thousands as collateral for a single trade.
This is where margin accounts come into play. A margin account literally means that a specified portion (margin) of the value of the trade is required from the trader as collateral in order to execute the trade. The multiplier of the broker’s portion is called the leverage.
So the brokers enable trading for retail traders like you and me via margin accounts. The broker would basically say to you, “look, if you can afford 2% of the amount required as collateral, then we will provide you the remaining 98% for the trade”.
With the margin facility provided by the broker, now you have to contribute only the 1934.98 USD (2%) to be held as collateral to open a trade for 1 standard lot on the EURUSD.
The proportion of the contribution to the trade by the broker is called leverage. In the above example, the leverage of the account was 1:50.
What this really means is now you control 100,000 USD with just a 2000 USD. On first impression, it looks like a great deal. This is one of the trader’s fallacies. More leverage is not always good for trading.
There is a famous saying – “Leverage is a double-edged sword”. You can use leverage to your advantage only if you know both sides of it. A deep dive into the workings of leverage is beyond the scope of this article and warrants a post of its own.
This is a basic outline of the fundamental concepts in forex trading.
These are just basic terms and concepts in forex, I am certain that you already knew them. But the important thing is to have a proper understanding of the fundamental stuff that can make or break your success as a trader. It does not matter if you have a highly profitable trading strategy. Even a perfect winning strategy cannot make you money unless you know the basic concepts such as margin, leverage, lot size and pips.
- Definition of a pip on AVA Trade website