Pips are the only way for forex traders to determine how a currency pair’s price has moved within a short period, e.g., seconds, minutes, or hours.
To successfully trade day trades, you need to understand pips, such as how they work and what they tell you.
However, pips may seem complex for the first time, but they’re actually meant to make the forex trading business relatively simple to understand. By reading this essential guide, you will learn about pips’ important things.
How do the forex pips work?
In foreign exchange (forex), a pip is a fundamental concept. To present exchange quotes, forex pairs are used along with ask quotes and bids perfect to four decimal places.
The simplest way to explain it is that, in forex, traders purchase or sell currencies whose value is based on their relationship with another currency.
Pips are used to measure the exchange rate movement. The least change in these pairs is one pip because nearly all currency pairs are quoted to four decimal places maximum.
To calculate the value of a forex pip, you have to divide 0.0001 or 1/10,000 by the exchange rate.
In this instance, if a trader is looking to purchase USD/CAD, he would buy USD and sell CAD simultaneously. Alternatively, to sell US dollars, a trader has to sell the USD/CAD pair and purchase Canadian dollars simultaneously.
To indicate whether a trade can result in a profit or loss and refer to the spread between the currency pair’s ask prices and bid, the traders used a term known as “pips.”
Moreover, two decimal places are used to quote the Japanese currency pairs (JPY), which is not the case elsewhere.
For USD/JPY and EUR/JPY currency pairs, the pip’s value is 1/100 divided by the exchange rate. For instance, if the EUR/JPY currency pair is quoted as 132.62, 1/100 ÷ 132.62 = 0.0000754 will be the pip’s value.
How to calculate the pip’s value?
To calculate the pip’s value for a particular currency pair, you need to determine each currency’s relative value.
Next, you have to divide the one pip, which is 0.0001, by the current rate of exchange, and then you have to multiply that particular figure with a notational amount that you want to use for trading. Let’s have a look at an example to get a better understanding.
For example, EUR/GBP is 29 pips higher, the opening value is 0.8685, and the closing value is 0.8714. Also, consider that a trader invests $350,000 in the pair at the opening.
As a result, 35 per pip or 350,000 x 0.0001 would be the GBP’s number invested per pip. Therefore the per pip’s value will be 35/0.8714, equivalent to €40.17. In other words, the 29-pip gain equates to €1,164.93 in profit.
Overall, the guide helps you understand how to apply the pips to calculate your total gain or loss while trading. In currency pairs without the Japanese yen, a pip represents the fourth decimal place, the smallest increment by which a currency pair can change in value.
The pip is positioned at the second decimal in currency pairs involving the Japanese yen. Lastly, understanding a trade setup’s Stop Loss helps determine the optimal position size to ensure you are within your risk per trade limits.
Content Sources: https://www.babypips.com/learn/forex/pips-and-pipettes , https://www.fxcc.com/what-is-a-pip-in-forex , https://en.wikipedia.org/wiki/Percentage_in_point