Author: Thomas Brock

7 feb 2024

A pip in forex is a basic unit of measurement of the price movement of a currency pair in the forex market. The term "pip" is an abbreviation of "Percentage In Point" or "Price Interest Point". Pips are used by traders to express profits or losses, as well as to indicate spreads - the difference between buy and sell prices.

Traditionally, a pip is 0.0001 for most currency pairs, which is 1/100th of a cent or one basis point. For example, if EUR/USD moves from 1.2050 to 1.2051, the pair is said to have moved one pip. However, there are exceptions, such as for Japanese Yen pairs (e.g. USD/JPY), where a pip equals a change in the second decimal place (0.01).

Understanding what pips are and how they work is essential for those who trade forex. This basic unit of measurement helps traders assess the size of potential profits and risks in various trading operations and money management strategies.

Traditionally, a pip is 0.0001 for most currency pairs, which is 1/100th of a cent or one basis point. For example, if EUR/USD moves from 1.2050 to 1.2051, the pair is said to have moved one pip. However, there are exceptions, such as for Japanese Yen pairs (e.g. USD/JPY), where a pip equals a change in the second decimal place (0.01).

Understanding what pips are and how they work is essential for those who trade forex. This basic unit of measurement helps traders assess the size of potential profits and risks in various trading operations and money management strategies.

Now let's go directly to pips, which is the minimum price variability for most pairs - usually the fourth decimal place after the decimal point. For the Yen, it is usually two decimal places because of the low value of the Yen itself against other currencies.

This basic terminology will help readers to more accurately understand the following sections of this article on how pips work in the Forex market.

The concept of pips originated at the dawn of the currency market and is one of the main terms used in trading. Initially, currencies were traded using physical money and over telephones, and prices were indicated in a very crude form without the smallest details. With the development of computer technology and the internet, the situation has changed dramatically.

The introduction of standardised conditions and electronic order processing system allowed traders to operate with the smallest price changes, which led to the need to use more precise units of measurement. This is how the pip appeared as a minimum unit of rate change, which made the trading process more understandable and accessible for market participants.

The exact date of origin of the term is unknown; however, it can be assumed that it became widely used from the early 1970s after the collapse of the Bretton Woods system of fixed exchange rates, which facilitated the transition to floating exchange rates. This greatly increased the fluctuations in the foreign exchange market and the need for an accurate unit measure to gauge these fluctuations.

Today, the pip is a versatile tool for measuring profit or loss on Forex trades. It also helps in assessing risks and formulating money management strategies. The tradition of using the pip continues to live on due to its simplicity and versatility, making it an indispensable part of every Forex trader's lexicon.

The introduction of standardised conditions and electronic order processing system allowed traders to operate with the smallest price changes, which led to the need to use more precise units of measurement. This is how the pip appeared as a minimum unit of rate change, which made the trading process more understandable and accessible for market participants.

The exact date of origin of the term is unknown; however, it can be assumed that it became widely used from the early 1970s after the collapse of the Bretton Woods system of fixed exchange rates, which facilitated the transition to floating exchange rates. This greatly increased the fluctuations in the foreign exchange market and the need for an accurate unit measure to gauge these fluctuations.

Today, the pip is a versatile tool for measuring profit or loss on Forex trades. It also helps in assessing risks and formulating money management strategies. The tradition of using the pip continues to live on due to its simplicity and versatility, making it an indispensable part of every Forex trader's lexicon.

In order to understand how exactly the cost of one pip is calculated, let's consider a simple example. Let's imagine that a trader makes a trade on EUR/USD, which is one of the most traded currency pairs. If the quote for EUR/USD changes from 1.1050 to 1.1051, it means that the price has changed by 1 pip.

- The profit or loss from a price change can be calculated by multiplying the pip value by the lot size (batch) and the number of pips in the price movement. For example:
- Standard lot size: 100,000 units of the base currency
- Movement: 15 pips
- If a trader uses a standard lot and the price moves for his benefit by 15 pips, the profit will be:
- 100,000 (lot size) 0.0001 (cost per pip for a standard EUR/USD lot) 15 (number of pips of movement) = $150.

Today many brokerage companies provide quotes with extended accuracy - so-called decimal or fractional pips - which makes it possible to even more accurately determine price changes and potential trading results...For example: Whereas previously the last fourth decimal place was the minimum displayed change for most major currency pairs typical EUR/USD), this can now be an additional digit - the so-called "decimal" or "fractional". This means an even more precise measurement: for example, if EUR/USD moves from .10500 to .10505 we're talking about a move of half a punt or "5 fractions"

When creating a trading strategy, it is necessary to consider the pip value for each currency pair you are working with. You should also determine how many pips can be lost or gained on a single trade. This is related to the level of stop loss (stop loss) and profit target (take profit), which are set in pips.

Strategies can be based on technical analysis, which uses various indicators and models to predict price movements, or on fundamental analysis, which focuses on economic news and political events. Either way, measuring price changes in pips will help traders make more accurate decisions about entering or exiting trades.

Strategies can be based on technical analysis, which uses various indicators and models to predict price movements, or on fundamental analysis, which focuses on economic news and political events. Either way, measuring price changes in pips will help traders make more accurate decisions about entering or exiting trades.

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When analysing the market through the prism of pips, a trader is able to objectively assess price fluctuations without being bound to specific numbers. This is especially useful for traders working with many different currency pairs and assets.

Using techniques such as counting the number of pips from recent highs to lows (or vice versa) can help identify support and resistance levels. It is this data that is often used to determine the opening or closing points of transactions.

Analysing the widening or narrowing of the spread is also important - it can indicate an increase in market volatility before economic news or a change in trend.

Using a standard value to measure changes makes it possible to easily recalculate the result of operations regardless of lot size and contract volume. This approach to analytics makes the process more universal and systematised.

Using techniques such as counting the number of pips from recent highs to lows (or vice versa) can help identify support and resistance levels. It is this data that is often used to determine the opening or closing points of transactions.

Analysing the widening or narrowing of the spread is also important - it can indicate an increase in market volatility before economic news or a change in trend.

Using a standard value to measure changes makes it possible to easily recalculate the result of operations regardless of lot size and contract volume. This approach to analytics makes the process more universal and systematised.

Forex spread is the difference between the Ask and Bid prices of a currency pair. This difference is measured in pips and represents the main component of a trader's costs when opening a trade. The spread can be fixed or variable, depending on the specific market conditions and the broker's policy.

The commission, which the broker earns on each client's trade, in most cases consists in the spread. The wider it is, the higher the cost of the transaction for the trader. During periods of high market volatility, the spread can increase significantly, which should be taken into account when planning trades.

Understanding the relationship between spreads and pips helps to determine the real costs of trades. This knowledge is also necessary to calculate break-even points - the point at which potential profits begin to exceed spread costs.

The commission, which the broker earns on each client's trade, in most cases consists in the spread. The wider it is, the higher the cost of the transaction for the trader. During periods of high market volatility, the spread can increase significantly, which should be taken into account when planning trades.

Understanding the relationship between spreads and pips helps to determine the real costs of trades. This knowledge is also necessary to calculate break-even points - the point at which potential profits begin to exceed spread costs.

When working in Forex, novice traders sometimes make typical mistakes:

Avoiding these mistakes and making accurate calculations can minimise unpleasant financial consequences and improve the overall efficiency of forex trading.

- Misidentifying the pip price - For example, ignoring an additional number after the decimal point (decimal pip) can lead to inaccurate calculations.
- Lot size misconceptions - A trader may misjudge the number of units of the underlying currency in a lot, which will affect the calculation of the price per pip.
- Ignoring spread changes - Without taking into account possible spread fluctuations especially before economic news or events, a trader may face unexpected costs.
- Failure to account for swaps or commissions - Typically, overnight commissions or swap points must also be accounted for in long-term trading.
- Neglecting to add/subtract the spread when calculating Take Profit and Stop Loss targets - This can lead to these orders being set incorrectly.

Avoiding these mistakes and making accurate calculations can minimise unpleasant financial consequences and improve the overall efficiency of forex trading.

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