I thought this term, “pip” to be the strangest name for a way to measure price movements when I first started trading Forex in 2007. It took me a while to fully understand the concept, but it’s really very simple once you understand how currency pairs move.
In this lesson we’re going to discuss what a pip is and how the value is calculated. I’m going to try not go too far in depth on the subject simply because, well, frankly it’s a bit boring. Plus your broker will work most of this out for you. But it’s always good to know the basics.
What Exactly is a Pip?
So what the heck is a “pip”? A pip is the smallest unit of measurement to express the change in value between two currencies. So if EURUSD moves from 1.3550 to 1.3551 that .0001 rise in value is called a pip.
A pip is the last decimal place of a quotation. All currency pairs except for the Japanese Yen pairs go out four decimal places just like the EURUSD example above. For the Yen pairs a change in pip value would be USDJPY moving from 102.00 to 102.01.
Do note that some Forex brokers go out 5 decimal places for non-Yen pairs and 3 decimal places for Yen pairs. These are called “pipettes”.
For example a move in EURUSD from 1.35500 to 1.35501 would be an increase of one pipette. Likewise a move in USDJPY from 102.000 to 102.001 would be an increase of one pipette.
What is a Forex Pip Worth?
Well that depends on things such as the currency pair in question as well as the current market price. You see the value of one pip for a specific currency pair will change as the market price fluctuates.
The best way to explain how to value a pip is to look at an example.
Take USDCAD. Let’s assume that the currency pair is trading at 1.0800. In order to find the value of a single pip we first need to take the value change in the counter currency (CAD) and multiple it by the exchange rate ratio.
Sound confusing? Don’t worry, it’s really very simple. Here’s the calculation…
Value change in counter currency (.0001 CAD) x the exchange rate ratio (1 USD / 1.0800 CAD)
Or simply
[(.0001 CAD / (1.0800 CAD)] x 1 USD = 0.00009259 USD per unit traded
So what does all of this mean? Well, using this example if we traded 10,000 units of USDCAD, then a one pip change to the exchange rate would equal a 0.92 (approximately) USD change in the position value. To get this we simply take the 10,000 units and multiple it by 0.00009259.
10,000 x 0.00009259 = 0.9259
So in this example 1 pip is equal to 0.9259 USD with 10,000 units traded.
Summary
Now that your head is probably spinning, you’re probably asking yourself, “do I really need to know all of that?”. And the answer is…
No.
The truth is that all of this math is done behind the scenes by your broker. Which is great because that means all you have to do is learn when to click the “buy” and “sell” buttons. 😉
Although your broker takes care of the heavy lifting for you, it’s still beneficial for you to know how to manually calculate the value of a pip. You will become a more well-rounded trader for knowing it.