what is a pip
Online currency trading has its own terminology, which can be confusing to newcomers. Two terms that you will need to understand in order to be able to make sense of FX quotes are ‘pips’ and ‘pipettes’. These terms are units that are used to measure the amount that a price has changed in an online currency trade. Forex brokers do not charge a flat fee per trade. Most forex brokers charge commission through the quotes that they show for each currency. In forex, a spread is the difference between the bid and the ask price, and these spreads are calculated by pips.
A pip is a very small number. If, for example, the EUR/USD moves from 1.2155 to 1.2156 then that’s a difference of 0.0001 – or, one pip. The standard quote at most online FX brokers is four decimal places. However, f the currency pair includes the
Japanese Yen (JPY), then pips are counted differently because the currency quote goes to two decimal places.
Some brokers go a little further – quoting to five or three depending on the currency pair. In this case, when a currency moves by 0.00001 it has moved one pipette.
The broker’s commission is built into the spread, and is usually a certain number of pips. The exact number of pips will vary depending on how popular the currency in question is. Frequently traded currencies will have low pip values, while rarely traded, more risky currencies, will have higher pips. Each broker sets their own pips and spreads. Before you start trading with a new broker, make sure you understand the terms and conditions of that broker, and how they calculate their pips. Some brokers have a fixed pip rate for most currencies. If you trade traditionally “expensive” currencies then this rate could work out well for you. If you usually trade popular pairs, you may want to look for a broker that allows you to trade them at a low price. It pays to run the numbers with a few different companies.
To calculate the value of a pip, you divide the pip (0.0001 or 0.01 if the currency pair involves JPY) by the exchange rate. If the exchange rate you’re quoted isn’t the exchange rate you’re interested in then you’ll need to perform one extra step to convert the currency into that exchange rate.
Why would you want to do all of this? Well, knowing the pip value gives you an idea of how much you’re making (or losing, if the trend is down) when you see the pip movement. It also gives you an idea of how much you’re paying the broker (since online FX brokers build their commission into the spread). It’s a good idea to look for small pips and tight spreads, which will give you the chance to earn from your trading, without having most of the money go to the forex broker.
The good news is that most good online FX brokers have the facility to calculate pip values built-in to their online trading platform. This makes it easy for you to see what’s happening with your online currency trading, without having to pull out a calculator every few minutes!
Now that you understand what is meant by a pip, and why it’s important to be able to judge their value, you’ll be in a better position to judge your daytrading activities and maximise your profits. A few pips may not seem like much, but it can be a big difference over the course of a whole trade, and is a major part of your FX quote.
Want to learn more about Forex term, why not check out our Forex glossary.
what is a pip