The acronym PIP, in the term ‘forex pip,’ stands for Price Interest Point or Percentage In Point. It is a measure of profits and losses in forex trading. A forex pip is the smallest possible increment in the price of a currency.
Changes in this unit help traders in determining the degree of rise or fall in the values of currencies. In the forex market, prices of currencies (except Japanese Yen, which is quoted to the second decimal point) are quoted to the fourth decimal point. The last place holder is called a pip. Therefore, one pip is 0.0001 (1/10,000th) of the rate of a currency. The actual value of a pip is related to the lot size traded. For the standard lot of $100,000, a pip is approximately USD10, depending on the forex pairing.
Forex spreads (buy quote minus sell quote), the major cost of forex trading, are also calculated using pips. In the forex market, prices of currencies are quoted to the fourth decimal point. For example, the EUR/USD quotes read 1.3200/02. In this case, the spread is calculated by subtracting 1.3200 from 1.3202, i.e. 2 pips.
In the forex market, there is no universal currency that one is trading in. Although the US dollar is the most traded currency, it is not a part of all trades. The foreign exchange values, therefore, need to be determined in a standard unit. This is where the need of forex pip arises. If beginners trade in one currency pair daily, they can quickly get an idea of the profits that one pip represents.
When the value of the forex pip is high (corresponding to the transaction value), losses can multiply with high leverage when the market goes against you. Brokers offering leverage as high as 400:1 aim to make money by offering much more than what a trader actually needs. They expect traders to close their deals for a greater spread.
Understanding the concept of forex pip can help a trader estimate the return on investment and conduct forex trading more accurately.
