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Lesson 4: What is a PIP?

what is a pip, pip value, pip in forex, forex pip

what is a pip, pip value, pip in forex, forex pipThe two previous articles were an introduction to Forex (Introduction to Forex first part, Introduction to Forex second part). Now I will explain the first elements: how is built a currency pair, what is a pip, and what is its value.

First a brief summary. Currency abbreviations always consist of three letters. The abbreviations for the most important currencies are:

USD = US Dollar

CAD = Canadian Dollar

EUR = Euro

GBP = British Pound

CHF = Swiss Franc

JPY = Japanese Yen

AUD = Australian Dollar

NZD = New-Zealand Dollar

The first abbreviation mentioned in a currency pair is called the base currency, the second quote currency. So, looking at the GBP/USD, the GBP (British Pound) is the base currency, while the USD (US Dollar) is the quote currency.

Each currency exchange, therefore, involves two currencies and is merely the price of one currency against another. Two currency abbreviations, separated by a symbol, usually "/" or "-", make a currency pair (i.e. GPB/USD or GBP-USD).

 

The exchange rate

The exchange rate is displayed on the right of the currency pair; for example USD/CAD 1.2684. It indicates that a unit of the American Dollar (the base currency) can be traded at 1.2684 Canadian Dollars (quote currency). So, if you buy the base currency, the exchange rate specifies how much you have to pay in quote currency to get a base currency unit. In the example, buying 1 US Dollar requires 1 Canadian Dollar and 26 cents (nearly 27 cents).

Conversely, if you sell the base currency, the exchange rate tells you how much you get in quote currency for each unit of base currency.

Exchange rates are usually expressed with four decimal places (i.e. AUD/NZD 1.1128), except for the currency pairs that including Japanese Yen (JPY), which are written with two decimal places (i.e. USD/JPY 113.56).

 

Open a  position, go long, go short

The base currency is the currency you are rooting for when you buy (go long), the quote currency is the currency you are rooting for when you sell (go short) a currency pair. Sticking with the GBP/USD example, when you think the British Pound will go up compared to the US Dollar, you go long on GBP/USD; if you think it will fall, you go short on GBP/USD.

Buying or selling currency is called opening a position. Do you think the Euro will go up compared the US Dollar? Then you open a long position on the EUR/USD. Do you think the Euro will fall compared to the British Pound? You open a short position on the EUR/GBP.

So "go long" (or "open a long position") means buying the currency pair, and then opening a buying position, while "go short" (or "opening a short position") means selling the currency pair, and then open a position for sale. It follows that the long position is bullish, as opposed to that short, which is bearish.

 

The meaning of "bull" and "bear"

Speaking of "bull", we refer to a market that is characterised by an upward trend. Why is this animal called into question? Simple: if you think of the bull's movement when attacking the prey, you can note that these animals are used to hit, with their horns, from the bottom up. That is why they can be considered "bullish". As a result, a growing market is bullish.

When the market has a downward trend, specialists define it as a "bear". Even in this case, the explanation of the use of this expression must be identified in the movements that this animal does when it attacks the prey: the blows it gives with its legs go from top to bottom. Therefore, a falling market is bearish.

 

What is a pip?

Pip is the smallest measured unit of a currency rate. PIP is the acronym of “Price Interest Point”. More simply though, a pip is what we in Forex would consider a “point” for calculating profits and losses.

With most currency pairs, this is the fourth number behind the comma. For the Japanese Yen, however, it is the second number behind the comma, because the Yen is about a 100 times less valuable than the other important currencies).

For example GBP/USD 1.3168. If the currency pair rises at 1.3183, we say that it has moved up or is increased by 15 pips. If instead, it drops at 1.3163, we say that it has decreased or moved down by 5 pips. Another example USD/JPY 113.56. If the cross rises to 113.80, we say that it has increased by 24 pips, if instead, it drops to 113.34, we say that it has decreased by 22 pips.

Additional transparency is provided through most electronic platforms as each currency pair is quoted with precision to 1/10th of a pip.

A figure represents a movement of 100 pips. So if GBP/JPY moved for two figures, it means the movement was 200 pips.

 

What is the value of a pip?

Now, let’s identify what the actual value per pip is. The value of a pip varies depending on the amount invested. I will show you how to calculate a pip value with a couple of examples. I start with EUR/USD.

If I have a trading account in US Dollars, then I will see $ 0.0001 of profit or loss for every 1 pip movement that the EUR/USD makes in the market. Then I have to multiplicate it for the size of my trade. If for example, I invested 35,000 Dollars I have to do: $ 35,000 x $ 0.0001 = $ 3.5 profit or loss on my account for every 1 pip of movement of EUR/USD.

Now, if instead, I have a trading account in Euros (EUR), British Pounds (GBP), Australian Dollars (AUD), etc., I have to convert $ 3.5 into the currency of my trading account. For my Euros trading account, I have just to divide $ 3.5 for the current EUR/USD exchange rate which at the time of writing of this chapter is 1.1774. So, $ 3.5 divided by 1.1774 = € 2.94. So now I know, for my Euros account, what is the profit or loss I get for each pip movement with a trade of $ 35,000.

However, it is simpler convert $ 0.0001 into the currency of own trading account and then, multiplicate it for your position size, whatever it is.

Let’s see the second example with GBP/JPY. This time a pip is no more $ 0.0001 but Yen 0.01 because it is a currency pair with the Japanese Yen. So, following the advice above, we convert 0.01 Yen into the currency of our trading account. So, for an account in US Dollars, we have to divide 0.01 by the current USD/JPY exchange (113.56), and we get a value of $ 0.00009. If your position size is of $ 35,000 for finding the value of a pip for your trading account you have to multiplicate 0.00009 x $ 35,000 = $ 3.15.

The same procedure should be followed for whatever else currency of your trading account. If you do not like to do all of these calculations, there are tools to find the value of a pip for your position. You can find one of them on my website, Trading with David, another on Myfxbook.

In the next article, we will see how to open a position and other elements of a currency pair.

 

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