If you are interested in the forex market or intend to enter and trade in it, you may have come across the term “pip” or “point” or “points.” This is a common and widely used concept in forex trading, but what is the definition of a pip/point? In this article, we will answer this question and explain the meaning of a pip and the usefulness of this concept when trading forex.
A pip is a price movement that has a specific value depending on the market being traded. More simply, it is a standard unit for measuring how much the exchange rate changes in value. Initially, when we look back at its origin, we will see that a pip was actually the smallest increment in which the forex exchange rate moved. Although more precise pricing methods have emerged since then, it remains the basis for calculations in forex trading. This original definition is no longer entirely accurate, as traditionally, foreign currency prices were quoted to a specific number of decimal places—most commonly four. Originally, a pip represented a movement of one point in the last quoted decimal place.
Many brokers now quote forex prices to additional decimal places; however, this means that a pip often no longer corresponds to the last decimal place in the quote. It is considered a standardized value across all brokers and platforms, making it extremely useful as a measure that allows traders to communicate under the same terms without any errors. Without this specific unit, there would be a risk of falling into computational confusions when pricing the sizes of contracts traded in the forex market, especially when we speak in general terms like points or numbers.
For most currency pairs, though not all, one pip is a movement in the fourth decimal place. The most notable exception is the arrangement of decimal places in forex pairs that include the Japanese yen. For pairs that involve the Japanese yen, one pip is a movement in the second decimal place.
For example, let’s assume you want to trade the euro against the US dollar (EUR/USD) and you decide to buy one lot. One lot equals 100,000 euros, and one pip is equal to 0.0001 for the euro-dollar pair. Therefore, the value of one pip for one contract is 100,000 × 0.0001 = 10 US dollars. We can then calculate the profit or loss.
Let’s say you bought the euro against the US dollar at a price of 1.16650, and then later closed your position by selling one contract at 1.16660. The difference between the two is:
1.16660 – 1.16650 = 0.00010
In other words, the difference is 1 pip. You would have made a profit of 10 dollars. If we look at these sample numbers from a different angle, we can clarify what a pip is in trading.
Let’s assume you opened your position at 1.16650 and bought one contract, which is equivalent to buying 100,000 euros. Theoretically, you are selling dollars to buy euros, and the value of the dollars you sell is determined by the exchange rate by default.
