Understanding Pips
March 6, 2009 by admin
Filed under Forex Fundamentals
Understanding Pips
In Forex, you will hear the term "Pips" a lot. But what is a Pip? "Pip" is derived from "percentage in point". A Pip is the smallest unit of value that a currency pair can be valued at. To get an idea of what I am talking about, let’s look at Euros and US Dollars. Let’s say a Euro is worth 1.4694 US Dollars. So the EUR/USD is 1.4694. The "4" on the end is the smallest unit. In other words it is four ten-thousandths of a dollar. If you have 10,000 Euros you would have 14,694 US Dollars. In the case of Euro/USD, that "4" then is the smallest unit and that is where the Pip comes from. Let’s say the value of the US Dollar decreases relative to the Euro and it is now 1.4793 Dollars per Euro. In this case the Euro just gained almost 1 penny on the Dollar, meaning for every Euro you sell, you would receive about 1 more US cents. But the actual movement is under 1 cent, it is .0099. That means that the change was 99 pips. Since the last number is the smallest unit, we see a change of 99 from that. If the EUR/USD had gone to only 14,695, then the change would have been 1 pip.
In the case of many currencies, the pip is at the fourth decimal point. In the case of USD/JPY, only two decimal points are used because the Yen is so cheap relative to the Dollar. So a Pip in one currency doesn’t necessarily mean the same amount of decimal points. It depends on the currencies we are talking about.
A Pip doesn’t sound like much. If you have one Euro and you just made a few ten-thousandths of a US Dollar, you wouldn’t really care. However in Forex, most traders are trading large amounts of money. If you are leveraged and you are trading a lot of money, then even a few Pips can turn out to be a few hundred Dollars. Let’s say you have USD/JPY. The price for USD/JPY is 110.00. In other words, you can buy 110.00 Yen for 1 Dollar. How much is a Pip worth? Let’s say you have bought on margin 100,000 dollars worth.
Then how much is that Pip worth? To find this out, divide the volume of 100,000 by the number of Yen that you can receive. 100,000 divided by 110.00 = 909. Transform that into dollars and it’s $9.09. So if the USD/JPY goes from 110.00 to 110.01, and you have 100,000 on the line, then you just made $9.09. If it goes up by 10 or 20 pips, then you can multiply that by 10 or 20.
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