PIP is a term that is used very often in FX trading and it's therefore important for all FX traders to have a thorough understanding of the meaning of this term.
PIP = Price Interest Point
A pip basically measures the amount of change in the exchange rate for a currency-pair and typically denotes the minimum incremental change possible.
Example: for currency pairs where the price is displayed with four decimal places, one pip will equal 0.0001. So for EURUSD, a pip would represent the change in price from, say, 1.1013 to 1.1014
Please note that all Yen-based currency pairs are an exception to the rule as they are only quoted with two decimal places (0.01).
N.B. These days, many brokers provide fractional pip pricing, i.e. quoting currency pairs with 5 decimal places for example, if we were to use the quote mentioned above, it would read 1.10135, where the last digit (5), represents half a pip.
Determining the value of a PIP
Your risk is directly related to your pip-value and hence it is very important to be on top of how to calculate the value of a pip; the good news is that this is pretty simple.
The monetary value of each pip will depend on three factors:
- the currency pair being traded
- the size of the trade
- the exchange rate
Let's look at an example:
A trader is looking to buy EURUSD as he believes the Euro will appreciate relative to the USD. Using the price above, the quote is 1.1014. Let us also assume that the trader's base currency is USD. As the USD is listed secondly in this pair, the pip-value in USD will therefore be fixed. If the trader buys 1 standard lot, his pip-value will be USD 10 (or the difference between 100,000 x 1.1014 and 100,000 x 1.1013). If he buys 3 lots, his pip-value is USD 10 x 3 = 30.
The final amount of profit or loss associated with a given trade will depend on what currency pair is traded and which base-currency you are working with (i.e. which currency you have funded your trading account with). Let's assume that the trade who executed the long EURUSD trade above, is from the UK and has GBP as his base-currency. In this case he would take his USD pip-value and divide this with the spot-rate of GBPUSD. Assuming that GBPUSD trades at 1.5610, the GBP pip-value of the long EURUSD trade above (1 lot) would be GBP 0.6406.
Always take into considerantion that it is the second currency of a currency-pair that provides the value of a pip. Knowing this, it's easy to convert this value back to your own base-currency as long as you know that exchange-rate.
Pip-values are important as they vary greatly from currency-pair to currency-pair so always be sure to be on to of this value before you engage in a trade.