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What is a Pip in Forex: Learn Pips, Lots, and pip values for Better Trading
BY Janne Muta
|May 28, 2024If you are a newcomer to FX trading it can be confusing to read about lots and pips and pipettes and points. Too often these terms are used without any explanation and it can be frustrating having to go and browse the internet to understand what a pip is in Forex. No need to run around anymore in this article we explain in detail what this FX gibberish is about. You obviously need to understand the basics so we are here to help you!
Key Takeaways from This Article
- Understanding Pips in Forex Trading: A pip in Forex trading represents the smallest price movement in the currency market, typically 0.0001 for most pairs like EUR/USD. Knowing what a pip is helps traders calculate their potential profits and losses accurately.
- Importance of Lot Sizes in Forex: Forex trading involves different lot sizes: standard (100,000 units), mini (10,000 units), micro (1,000 units), and nano (100 units). Each lot size has its own pip value, influencing the risk and potential return on trades.
- Calculating Pip Values Across Currency Pairs: The value of a pip varies depending on the currency pair. For example, in EUR/USD, one pip equals $10 for a standard lot. Understanding these values is crucial for effective risk management and strategy planning.
- Role of Pips in Risk Management: By calculating the value of pips, traders can set precise stop-loss and take-profit orders, ensuring their trades align with their risk management strategies. This helps in maintaining a favourable reward-to-risk ratio and building profitable trading strategies.
First things first, what is a pip in Forex?
One pip used to be the smallest price movement in the FX market. That was when major FX pairs like were quoted with four decimals. For instance, as I write this EURUSD is quoted at 1.0861, meaning that you can buy this number of US dollars with one euro. The last digit, the number 1 in this case, is the pip.
As I said, the smallest fraction in the EURUSD change used to be 0.0001. So, if the market moved one pip it moved from 1.0861 to 1.0862 or to 1.0860. Note that JPY pairs are an exception to this rule. In USDJPY for example pip is the second decimal: 0.01. USDJPY was just moments ago quoted at 155.85 and is currently trading at 155.88 so the change equals to three pips (0.03).
Nowadays, brokers quote forex market rates with five decimals. Therefore, we now have new words to learn: Points and pipettes. These two words actually both refer to one tenth of pip or 0.00001 (remember pip = 0.0001). Using the same currency pairs as above one point move in EURUSD happens when the quote changes e.g. from 1.0861 to 1.08611 or to 1.08609.
The following charts show how the pips and pipettes are displayed in the MT5 trading platform.
In the MT5 Forex trading platform shown in the image, the big numbers in the buy and sell buttons represent the current bid and ask prices in pips.
Pipettes or points are shown to the right of pips with smaller numbers.
Why are pips important in trading?
Knowing what is a pip in Forex helps traders determine the impact of price fluctuations on their trades. We must grasp pip values, as these fundamental units of measurement for price movements allow us to calculate P&L, the profits and the losses. Understanding what is a pip in Forex and the exact value of a pip is crucial for evaluating how much a price movement will impact a trader’s position, helping them to evaluate risk and also the potential in any given trade.
Calculating Position Sizes Relative to Maximum Risk per Trade
Understanding pip values allows traders to calculate position sizes accurately, ensuring that the risk on any given trade aligns with their overall risk management strategy. For example, if a trader decides that their maximum risk per trade is $200, and each pip is worth $10, they can set a stop-loss order 20 pips away from their entry point. This precise calculation helps traders avoid overexposure and manage their capital efficiently.
Importance of Reward to Risk Ratio in Building Winning Strategies
The R/R ratio is essential in building and evaluating trading strategies. Consistently applying a favourable R/R ratio helps traders develop strategies that are more likely to be profitable over the long term. For example, a strategy that aims for a 3:1 R/R ratio requires only one winning trade out of three to break even. This ratio also allows traders to assess the performance of their strategies over time, identifying areas for improvement and ensuring they stay aligned with their trading goals. This is a how understanding what is a pip in Forex helps traders not only manage risks but also create profitable trading strategies.
Types of Lots and Their Pip Values in Forex Trading
Understanding pips in Forex and their values with different lot sizes is essential for effective risk management. There are four primary types of lots: standard, mini, micro, and nano. Each of these lot sizes have their own pip value. Let’s take a closer look.
Standard Lot
This contains 100,000 units of the base currency. For example, in the EURUSD pair, a standard lot is 100,000 euros. The pip value for a standard lot is $10. This lot size suits professional traders due to its higher potential returns. Note that risks are also greater when trading a bigger lot size.
Mini Lot
A mini lot consists of 10,000 units of the base currency. In the EURUSD pair, this equates to 10,000 euros. The pip value for a mini lot is $1. Mini lots are ideal for retail traders with moderate capital.
Micro Lot
This lot includes 1,000 units of the base currency. In the EURUSD pair, a micro lot is 1,000 euros. The pip value for a micro lot is $0.10. Micro lots are perfect for beginner traders or those testing new strategies due to their lower risk.
What are pips in Forex base and quote currencies
Because pip values are determined by the quote currency, we need to understand not only what a pip in Forex is but also what a quote currency is. In the foreign exchange market, currencies are traded in pairs, comprising a base currency and a quote currency. The base currency is the first currency in the pair and represents how much of the second currency, or quote currency, is needed to buy one unit of the base currency. For example, in the EUR/USD pair, EUR is the base currency and USD is the quote currency. If EUR/USD = 1.0841, it means €1 equals $1.0841.
Let’s take another example. Traders buy a currency pair if they believe the base currency will strengthen relative to the quote currency, and sell if they think the base currency will weaken. For instance, in the GBP/AUD pair, if GBP/AUD = 1.9070, it means £1 equals A$1. 9070. Here, traders speculate on the movement of the pound relative to the Australian dollar.
Importance of understanding base and quote currencies
Understanding base and quote currencies is crucial for calculating values for pips in different currency pairs. If the quote currency is other than USD to get exact pip values in USD terms you can use the following formula:
- Pip Value = (1 Pip / Exchange Rate) × Trade Size
Here’s an example using the EUR/GBP pair:
- Assume the exchange rate is 0.8600.
- Trade size is 10,000 units.
- The pip value calculation would be:
Pip Value = (0.0001 / 0.8600) × 10,000 = 1.1628 GBP
To convert this into USD, you need the current GBP/USD exchange rate. Assuming it is 1.3000:
- Pip Value in USD = 1.1628 × 1.3000 = 1.5116 USD
And, an example with the AUD/JPY currency pair:
- Assume the exchange rate is 104.24.
- Trade size is 10,000 units.
- The pip value calculation would be:
Pip Value = (0.01 / 104.24) × 10,000 = 1.1765 JPY
To convert this into USD, you need the current USD/JPY exchange rate. Assuming it is 110.00:
Pip Value in USD = 1.1765 / 110.00 = 0.0107 USD
By understanding how to calculate pip values in USD terms, we can accurately assess the potential impact of price movements on their trades, aiding in better risk management and strategy planning.
Calculating Profits and Losses Using Pips
Understanding what pips are in Forex and how pip values translate into profits and losses is something every Forex trader needs to understand. In this section I will provide practical examples to help you to visualise the impact of market movements and how these movements are calculated in real-world trading scenarios.
Example 1: Trading the EUR/USD Pair
Let's consider a trade involving the EUR/USD pair, where the trader is betting the market goes higher. He does this by buying euros and selling US dollars. Suppose the current exchange rate for EUR/USD is 1.1000.
- Scenario: You buy 1 standard lot of EUR/USD (which is 100,000 euros).
- Initial Exchange Rate: 1.1000
- Final Exchange Rate: 1.1050
The change in the exchange rate from 1.1000 to 1.1050 is 50 pips (1.1050 - 1.1000 = 0.0050, and since 1 pip for EUR/USD is 0.0001, this translates to 50 pips).
Calculating Profit using Pip Values:
Calculate the value per pip: For a standard lot, the pip value is $10 (since 100,000 units * 0.0001 = 10 units of the quote currency, which is USD).
Total Profit: Multiply the number of pips by the value per pip. In this case, 50 pips * $10 = $500.
So, the trader makes a profit of $500.
Example 2: Trading the USD/JPY Pair
Now, let's consider a trade involving the USD/JPY pair, where the trader is buying US dollars and selling Japanese yen. Suppose the current exchange rate for USD/JPY is 110.00.
- Scenario: You buy 1 standard lot of USD/JPY (which is 100,000 USD).
- Initial Exchange Rate: 110.00
- Final Exchange Rate: 110.50
The change in the exchange rate from 110.00 to 110.50 is 50 pips (110.50 - 110.00 = 0.50, and since 1 pip for USD/JPY is 0.01, this translates to 50 pips).
Calculating Profit using Pip Values:
Calculate the value per pip: For a standard lot, the pip value is ¥1,000 (since 100,000 units * 0.01 = 1,000 units of the quote currency, which is JPY).
Convert the profit to USD: Since the profit is in JPY, convert it to USD using the final exchange rate. In this case, 50 pips * ¥1,000 = ¥50,000. To convert to USD: ¥50,000 / 110.50 = $452.49 (approximately).
So, the trader makes a profit of approximately $452.49.
Example 3: Trading the GBP/USD Pair with a Mini Lot
Let’s take a look at an example involving a mini lot, which is 10,000 units of the base currency. Suppose you are trading the GBP/USD pair.
- Scenario: You sell 1 mini lot of GBP/USD (which is 10,000 GBP).
- Initial Exchange Rate: 1.2500
- Final Exchange Rate: 1.2450
The change in the exchange rate from 1.2500 to 1.2450 is 50 pips (1.2500 - 1.2450 = 0.0050, and since 1 pip for GBP/USD is 0.0001, this translates to 50 pips).
Calculating Profit:
Calculate the value per pip: For a mini lot, the pip value is $1 (since 10,000 units * 0.0001 = 1 unit of the quote currency, which is USD).
Total Profit: Multiply the number of pips by the value per pip. In this case, 50 pips * $1 = $50.
So, the trader makes a profit of $50.
Example 4: Trading the AUD/JPY Pair with a Micro Lot
For a smaller trade, let's consider a micro lot, which is 1,000 units of the base currency. Suppose you are trading the AUD/JPY pair.
- Scenario: You buy 1 micro lot of AUD/JPY (which is 1,000 AUD).
- Initial Exchange Rate: 80.00
- Final Exchange Rate: 80.50
The change in the exchange rate from 80.00 to 80.50 is 50 pips (80.50 - 80.00 = 0.50, and since 1 pip for AUD/JPY is 0.01, this translates to 50 pips).
Calculating Profit:
Calculate the value per pip: For a micro lot, the pip value is ¥10 (since 1,000 units * 0.01 = 10 units of the quote currency, which is JPY).
Convert the profit to USD: Since the profit is in JPY, convert it to USD using the final exchange rate. In this case, 50 pips * ¥10 = ¥500. To convert to USD: ¥500 / 80.50 = $6.21 (approximately).
So, the trader makes a profit of approximately $6.21.
Conclusion
After reading the article I’m sure you agree with me that understanding what a pip is in Forex trading and how pip values translate into profits and losses is fundamental for any trader. Pips represent the smallest unit of price movement and are crucial for calculating the impact of market fluctuations on a trader's portfolio. By mastering the calculation of pip values and their effect on different lot sizes, traders can manage their risk more effectively and make better informed trading decisions.
Real-world examples, such as trading the EUR/USD, USD/JPY, GBP/USD, and AUD/JPY pairs, demonstrate how these calculations are applied, offering valuable guide on how to construct a spreadsheet that helps you to quickly and efficiently calculate pip values as well as profits and losses.
Additionally, understanding how leverage amplifies both potential profits and losses is essential. With proper knowledge, traders can optimise their positions, maintain a favourable reward-to-risk ratio, and develop winning strategies. By integrating these principles into their trading approach, they can better navigate the Forex market, optimise their positions, and achieve their financial goals. This comprehensive grasp of pip values and their impact empowers traders to make more strategic and informed trading decisions, leading to long-term success in the dynamic world of Forex trading.
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Janne Muta holds an M.Sc in finance and has over 20 years experience in analysing and trading the financial markets.
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