Lesson 3: Currency Trading Conventions – What You Need to Know Before Trading

What are Pips in Forex

Overview

  • Pip = "price interest point".
  • A pip measures the amount of change in the exchange rate for a currency pair.
  • For currency pairs displayed to four decimal places, one pip is equal to 0.0001. Yen-based currency pairs are an exception and are displayed to only two decimal places (0.01).
  • Some brokers now offer fractional pips to provide an extra digit of precision when quoting exchange rates for certain currency pairs.
  • A fractional pip is equivalent to 1/10 of a pip.


OANDA introduced fractional pips - or "pipettes" - to allow for tighter spreads on certain currency pairs. For instance, it is possible to view the EUR/USD currency pair with pipettes (i.e. five decimal places), while currency pairs with the yen as the quote currency can be viewed to three decimal places instead of the default two decimal places.

Forex traders often use pips to reference gains or losses. For a trader to say "I made 40 pips on the trade" for instance, means that the trader profited by 40 pips. The actual cash amount this represents however, depends on the pip value.

Determining Pip Value

  • The monetary value of each pip depends on three factors: the currency pair being traded, the size of the trade, and the exchange rate.
  • Based on these factors, the fluctuation of even a single pip can have a significant impact on the value of the open position.
  • For example, assume that a $300,000 trade involving the USD/CAD pair is closed at 1.0568 after gaining 20 pips. To calculate the profit in U.S. dollars, complete the following steps:
    1. Determine the number of CAD each pip represents by multiplying the amount of the trade by 1 pip as follows:

      300,000 x 0.0001 = 30 CAD per pip

       

    2. Divide the number of CAD per pip by the closing exchange rate to arrive at the number of USD per pip:

      30 ÷ 1.0568 = 28.39 USD per pip

       

    3. Multiply the number of pips gained, by the value of each pip in USD to arrive at the total loss / profit for the trade:

      20 x 28.39 = $567.80 USD profit

    Additional Examples*

    Currency Pair Exchange Rate at Close Pip Change Trade Amount
    EUR/GBP 0.8714 +29 350,000 EUR
    • Number of GBP per pip: 350,000 × 0.0001 = 35
    • Per Pip Value: 35 ÷ 0.8714 = 40.17 EUR per pip
    • Trade Profit / (Loss): 29 pips × 40.17 = 1, 164.93 Euros
    Currency Pair Exchange Rate at Close Pip Change Trade Amount
    AUD/NZD 1.2703 -17 175,000 AUD
    • Number of NZD per pip: 175,000 × 0.0001 = 17.5
    • Per Pip Value: 17.5 ÷ 1.2703 = 13.78 AUD per pip
    • Trade Profit / (Loss): (17) pips × 13.78 = (-234.26) Australian Dollars
    Currency Pair Exchange Rate at Close Pip Change Trade Amount
    CHF/JPY 83.84 +18 500,000 CHF
    • Number of JPY per pip: 500,000 × 0.01 = 5,000
    • Per Pip Value: 5,000 ÷ 83.84 = 59.64 CHF per pip
    • Trade Profit / (Loss): 18 pips × 59.64 = 1,073.52 Swiss Francs
    Currency Pair Exchange Rate at Close Pip Change Trade Amount
    USD/JPY 91.16 -27 200,000 USD
    • Number of JPY per pip: 200,000 × 0.01 = 2,000
    • Per Pip Value: 2,000 ÷ 91.16 = 21.94 USD per pip
    • Trade Profit / (Loss): (27) pips × 21.94 = (-592.38) U.S. Dollars

    * For the sake of simplicity, assume all examples are buy transactions.

Naturally, all brokers claim they offer the best spreads, but simply saying something, does not make it so. It is up to you to do your investigative homework to identify brokers that offer the best value.

How Uncertainty in the Market Affects Spreads

  • Impending news, such as inflation reports and central bank meetings, are the most common events that cause spreads to widen.
  • Once the news of an event is absorbed by the market and it becomes clearer which way the currency will go, the spread generally snaps back to typical levels.
  • We'll talk more about spreads and what causes spreads to vary in Lesson 5 – A Primer to Fundamental Analysis.
Loading nanoRep