Understanding Pip
Monday, 8 November 2010
This is probably the most used word in term of currency trading; Pip. Not only that it is easy to be spelled but also because it is what traders hunt in currency trading. Many trader say that knowing how many pips you gain or lose is more important than knowing how much money you gain or lose (in few case, I agree with this opinion).
In brief and general, forex pip is the smallest price change that a given exchange rate can make. Therefore defining ‘1 pip‘ for each currency pairs is dependent on the exchange rate (quoted price) given to the related pair. Let me take GBP/USD, GBP/JPY as an example. What is ‘1 pip’ for those pairs?
For example, Broker x has recently implemented five decimal points for GBP/USD (eg, 1.83972). This subsequently gives different definition to ‘what 1 pip is‘ for this pair (compared to the above example). In this case, ‘1 pip’ for GBP/USD is equal to 0.00001 price change.
So how much is a pip worth? The value of a pip depends on the size of the contract (or lot) that is traded. Most online forex brokers offer regular contracts (or lot) sizes of 100,000 units of the base currency. With this figure in mind, we could determine what a pip is worth.
Let's take the quote example: EUR/USD = 1.2125
If 1 euro equals 1.2125 dollars, then 1 lot (or contract) of 100,000 euros should be worth 121,250 dollars and a fluctuation of 0.0001 (1 pip) should be worth 100,000 x 0.0001 = 10 dollars. Therefore, every time the price of the euro versus the dollar fluctuates by one pip, the value of each contract changes by 10 dollars. For currencies that are quoted in terms of dollars (that is, when the USD is the quote currency), the PIP value is fixed (10 dollars if the currency is quoted to the fourth decimal place). This is what is called a "static pip value" because the value is constant relative to the dollar. Mayor currencies (other than the EUR/USD) with a static pip values are the GPB/USD (British Pound versus the US Dollar - also known as "cable") and the AUD/USD (Australian Dollar versus the US Dollar - also know as "aussie").
Are there currencies with a "variable pip value?" Yes there are. A currency with a variable pip value is one that has the dollar as the base currency. The mayor currencies or "mayors" with a variable pip value are the USD/JPY, the USD/CHF (US Dollar versus the Swiss Franc), and the USD/CAD (US Dollar versus the Canadian Dollar). Using the earlier example of the USD/JPY = 107.65, if:
1 USD equals 107.65 yen, then 1 lot of 100,000 dollars should be worth 10,765,000 yen and one pip should be worth 100,000 x 0.01 = 1000 yen. If we want to turn this value into dollars, we have to divide by the current exchange rate (107.65 yen per dollar). Thus, 1000 / 107.65 = 9.29 dollars. We automatically conclude that the value of one pip in the dollar-yen currency pair (in terms of dollars) will always vary as the exchange rate varies.
In brief and general, forex pip is the smallest price change that a given exchange rate can make. Therefore defining ‘1 pip‘ for each currency pairs is dependent on the exchange rate (quoted price) given to the related pair. Let me take GBP/USD, GBP/JPY as an example. What is ‘1 pip’ for those pairs?
- GBP/USD are commonly quoted into four decimal points (eg, 1.8397). Then ‘1 pip‘ for GBP/USD in this case is equal to 0.0001 price change (be it higher or lower).
- GBP/JPY are commonly quoted into two decimal points (eg, 193.57). Then ‘1 pip’ for GBP/JPY in this case is equal to 0.01 price change (be it higher or lower).
For example, Broker x has recently implemented five decimal points for GBP/USD (eg, 1.83972). This subsequently gives different definition to ‘what 1 pip is‘ for this pair (compared to the above example). In this case, ‘1 pip’ for GBP/USD is equal to 0.00001 price change.
Pip Value
The term PIP is used often. A pip, which stands for "price interest point," represents the smallest fluctuation in the price of a currency. This is similar to the "tick" concept for stocks.So how much is a pip worth? The value of a pip depends on the size of the contract (or lot) that is traded. Most online forex brokers offer regular contracts (or lot) sizes of 100,000 units of the base currency. With this figure in mind, we could determine what a pip is worth.
Let's take the quote example: EUR/USD = 1.2125
If 1 euro equals 1.2125 dollars, then 1 lot (or contract) of 100,000 euros should be worth 121,250 dollars and a fluctuation of 0.0001 (1 pip) should be worth 100,000 x 0.0001 = 10 dollars. Therefore, every time the price of the euro versus the dollar fluctuates by one pip, the value of each contract changes by 10 dollars. For currencies that are quoted in terms of dollars (that is, when the USD is the quote currency), the PIP value is fixed (10 dollars if the currency is quoted to the fourth decimal place). This is what is called a "static pip value" because the value is constant relative to the dollar. Mayor currencies (other than the EUR/USD) with a static pip values are the GPB/USD (British Pound versus the US Dollar - also known as "cable") and the AUD/USD (Australian Dollar versus the US Dollar - also know as "aussie").
Are there currencies with a "variable pip value?" Yes there are. A currency with a variable pip value is one that has the dollar as the base currency. The mayor currencies or "mayors" with a variable pip value are the USD/JPY, the USD/CHF (US Dollar versus the Swiss Franc), and the USD/CAD (US Dollar versus the Canadian Dollar). Using the earlier example of the USD/JPY = 107.65, if:
1 USD equals 107.65 yen, then 1 lot of 100,000 dollars should be worth 10,765,000 yen and one pip should be worth 100,000 x 0.01 = 1000 yen. If we want to turn this value into dollars, we have to divide by the current exchange rate (107.65 yen per dollar). Thus, 1000 / 107.65 = 9.29 dollars. We automatically conclude that the value of one pip in the dollar-yen currency pair (in terms of dollars) will always vary as the exchange rate varies.
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Need to Know