A pip in forex trading; what on Earth is this? When traders are introduced to the FX market, counting pips is one of the first few things they study. Every financial instrument has unique measurement units, like ticks in futures and pips in currencies.
You may wonder about the importance of learning to count pips in forex. Traders need a way to quantify the micro exchange rate variances they trade into real monetary terms. Ultimately, our success is determined by our profits and losses.
Secondly, learning what a pip in forex trading is helps to quantify the costs of spreads. Lastly, pips are a key component in position sizing and risk to reward ratios.
What are pips in Forex trading? How do pips work?
A pip in forex trading denotes the slightest change in the exchange rate to the right of the decimal, typically the fourth place (0.0001). It is two decimal places for JPY or yen forex markets (0.01).
Pip is shorthand for ‘percentage in point or price interest point’ and is the standardized unit of value change for FX and crypto.
In some literature discussing forex trading pips, it’s common to see mention of a pipette or micro pip. This simply refers to the last decimal place in the exchange rate of five-digit forex pairs (third decimal place for yen pairs).
So, how would we express pipettes in a real-life scenario? For instance, if the price of EUR/USD went from 1.10812 to 1.10850, this would represent a 38 pipette difference (50 – 12), or 3.8 pips difference.
Alternatively, if USD/JPY moved from 10.432 to 10.402, this would be a 30 pipette variance (30 – 2) or 3 pip variance.
However, a pipette is not a measurement unit we commonly use, meaning it’s not something to worry about. If you’re using the MT4 or MT5 platform when measuring distances, you will see an extra zero or decimal place, which you should ignore.
Let’s look at the traditional four-decimal price change as we observe a pip in forex trading.
The image above is a screen portion you’ll typically see displaying the spread on MetaTrader 4 when executing an order. Here, the difference is two pips when subtracting the two fourth-decimal numbers (67 and 65).
Let’s look at an example involving a yen pair.
Remember what we said about yen pairs? We look at the second decimal place. Here, EUR/JPY has moved from 106.362 to 106.372, resulting in a one-pip difference (37 – 36).
How to calculate pips in forex
Naturally, the next question you may have is how much is a pip worth? While we have calculators (more on this later) to aid with the math, it’s helpful to understand this concept when it comes to position sizing.
Firstly, it depends on how many units you seek to trade of the base in a forex pair, the conversion price, and the denominated currency. Therefore, pips value varies depending on the market, and adjusting accordingly is crucial.
The formula for most forex pairs is:
0.0001 X unit size X conversion price
0.01 X unit size X conversion price
Let’s look at the units part. Below is a list of the four lot sizes we use before deciding on a pip value in forex.
- A standard lot size is 100 000 units of the base currency (1 lot)
- A mini lot size is 10 000 units of the base currency (0.1 lots )
- A micro lot size is 1 000 units of the base currency (0.01 lots)
- A nano lot size is 100 units of the base currency (0.001 lots)
Next, we have the conversion price, referring to the exchange rate for the pair you are seeking a pip. For instance, if you wish to know the pips value for USD/CHF and your account currency is USD, the conversion price is the USD/CHF exchange rate.
If the pair was CHF/JPY and your account was EUR, you would use the EUR/JPY price to get the pips value for CHF/JPY.
Lastly, your denominated account currency will change the value of a pip in forex. USD remains the standard here, but many traders use other currencies like EUR, GBP, JPY, etc. Fortunately, a calculator will make your job easier, so you don’t need to scratch your head.
Account currency: USD
Unit trade size: 100 000
One pip in decimal form: 0.0001
Imagine you wanted to trade a standard lot (100 000 units) on USD/CHF where the current exchange rate is 1.00007. The pip value would be:
0.0001 * 100 000 / 1.00007 = $10
So, with this lot size, every pip change is worth $10. So, if the pair moved 30 pips in your favour, this would result in a floating profit of $300 (30 X$10).
For EUR/USD, AUD/USD, GBP/USD, and USD/CHF, the forex pip value is generally:
- $0.001 for a nano lot
- $0.1 for a micro lot
- $1 for a mini lot
- $10 for a standard lot
Yet, this may change slightly depending on the exchange rate.
Account currency: EUR
Unit trade size: 10 000
One pip in decimal form: 0.01
Let’s picture that you wanted to trade a mini lot (10 000 units) on CHF/JPY, and you were using a EUR-denominated account. Due to this, we would need the conversion price for EUR/JPY and not CHF/JPY.
Let’s assume the exchange rate for the former is 147.231. The forex pip value would be:
0.01 * 10 000 / 147.231 = €0.68
So, with this lot size, every pip change is worth €0.68. So, if the pair moved 15 pips against you, this would result in a floating loss of €10.2 (15 X€0.68).
Account currency: GBP
Unit trade size: 2000
One pip in decimal form: 0.0001
Let’s picture that you wanted to trade two micro lots (2000 units) on EUR/CAD, and your account was denominated in GBP. Due to this, we would need the conversion price for GBP/CAD and not EUR/CAD.
Let’s also assume the exchange rate for the former is 1.56930. The forex pip value would be:
0.0001 * 1000 / 1.56930 = £0.13
So, with this lot size, every pip change is worth £0.13. So, if this pair moved 100 pips in your direction, this would result in a floating profit of £13 (100 X £0.13).
The next illustration will be on the MetaTrader 4 platform, as some, particularly beginners, might struggle with measuring a pip in forex trading using this software.
Let’s imagine we wanted to calculate the pip difference on this bearish move from 1.16230 to 1.14728 on GBP/USD.
The first step is to head over to the icons above the chart and click the ‘crosshair.’ (a shortcut is Ctrl + F). This will activate the crosshair, which you can move then around.
We measure from two anchor points or swing highs/lows in pip trading. So, the next step is to hold the crosshair on the swing high, as performed in the chart above. While holding, you simply drag your mouse from the first point to your desired end point.
It’s crucial to keep holding and dragging at the same time, failing which the crosshair will disappear, and you’d have to start the process again.
If you’ve done the holding and dragging correctly, you will see different figures at the end point, as in the chart above.
When studying a pip in forex trading, we are interested in the middle number (1502), representing roughly 1502 pipettes or 150 pips.
What is a pip value forex calculator?
The scenarios above are a few examples of pips and how to work with them in action. Yet, it’s not hard to understand that this process is time-consuming. Manually figuring out how to count pips for every position beforehand would result in less-than-optimal entries and missed opportunities.
Luckily, as mentioned earlier, a pip forex trading calculator will make your life much easier. These automatically determine the pip value of a currency pair you wish to trade based on any lot size. This is what we demonstrated in our examples above.
Regardless of the variety, they all work the same. A good calculator will contain all the major and cross pairs, along with most of the exotic pairs. Calculators are available with most currency brokers and popular financial portals like Myfxbook and Investing.com.
It should also have various base currencies aside from USD. The calculator will present the pip value results based on real-time exchange rates.
Why is understanding pips in forex essential?
Let’s look at the importance of grasping what a pip in forex trading is.
The first reason is that traders need a measurement unit with a fine degree of accuracy. Exchange rates fluctuate every second, and we need something to count with, right? Still, despite this fast-paced nature, it’s essential to have something to quantify these movements to understand their magnitude.
A price change on a small time frame like the 1-minute chart might seem insignificant. However, when we express it as a pip value in forex, it may be noteworthy based on the distance and margin value.
Calculation of spreads
Let’s first mention that you don’t need to know the monetary spread cost in live trading. However, if you are comparing spreads across different brokers, understanding forex pip values can help in deciding what’s cheaper or more expensive.
Although spread differences for many pairs are minimal, this isn’t the case with less traded markets, most notably exotic pairs. So, you can quantify how much the spreads are in dollar figures, given the greater variances between brokers.
Here, a mere 5 pip difference between two forex dealers could mean a $100 variance for the more affluent trader.
Quantifying profits and losses
Risk-to-reward is one of the essential components of forex. It’s the idea of assessing the quality of opportunities based on how far the price could travel in your favour on multiple occasions. Here, we use a risk-to-reward (RR) ratio.
Of course, there is no recommended RR ratio as it depends on multiple factors ranging from trading style to win percentage. Yet, generally, the lower your win rate, the higher this ratio should be.
The higher your hit rate (especially for scalpers and day traders), the lower your RR ratio needs to be. On the other hand, swing traders and position traders can survive with a lower hit rate since their RR ratio is higher.
1:2 is a commonly used RR ratio, which we calculate based on the number of pips. With this ratio, a trader plans to make double their risk for every trade.
If their stop loss on a position is 40 pips, their ideal profit target should be at least 80 pips. Hence, this is another way where understanding a pip in forex trading comes in handy.
Although we count pips when forecasting potential profits or losses, it’s better to quantify these in real monetary expressions. At the end of the day, trading forex is a game of money, not points or percentages.
Some traders believe focusing on their positions in terms of forex trading pips won or lost will enhance their performance as there is less focus on the actual money. However, this has a counterproductive effect because it can blind a trader to the risk they are taking.
Even if you risk 20 pips for a position, that may be a massive amount if it accounts for 10% of your equity.
The point is that pips value is beneficial for measuring risk-to-reward parameters but always translate this into dollars, euros, or whichever currency you’re using.
As ‘risk managers,’ position sizing 101 is about forex pip values. It may seem basic, but mastering what a pip in forex trading is goes a long way as a trader. Many analysts tend to skip off the simple stuff and dive straight into the advanced. So, it’s vital to grasp this concept fully.