Pip is one of the most important terms of the forex market. This is why it is essential to understand what it is and how it relates to currency positions in forex. Read on to learn more.
What are Pips?
To understand what pip is, you should first get acquainted with the concept of a quotation (quote). A quotation is basically an exchange rate of a given currency pair. An example of a quotation is 1.21821 (EUR/USD). What it says is that 1 euro can be bought/sold for 1.21821 dollars. The last digit of the quotation is a point. Ten points equal one pip.
It is also common to use the quotation, priced out to four decimal places rather than five, as shown above. In cases like this, the quote ends with pips – the fourth digit (1.2182), rather than points (the fifth digit). The five decimal quotes used in MT4 and MT5 trading terminals reflect the price more precisely.
A pip (an acronym for "percentage in point") is the second-largest price move that can take place in a currency pair. So if the price of EUR/USD changed from 1.2183 to 1.2184, you would say it grew by 1 pip. If the quotation turned from 1.21821 to 1.21831, it would mean that the price went up by 10 points or 1 pip.
One thing to bear in mind is that the USD/JPY currency pair has a slightly different price, being quoted either to two or three decimal places, e.g., 109.922.
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Pips and Spreads
Pips are commonly mentioned when speaking about spreads. Spread is a difference between the buy (ask) and sell (bid) price of a currency pair. The Bid price is lower than the Ask price unless the spread equals zero. Aiming to reduce transactional costs when buying and selling currency pairs, traders are interested in trading with brokers who provide the lowest spreads.
Calculate the Value of a Pip
Pips are used to measure movement in the exchange rate. The smallest change that can take in a pair’s price is 1 point. The second-largest change that can take in a pair’s price is 1 pip equal to 10 points. To calculate the measure of a pip, divide 1/10,000 or 0.0001 by the quotation.
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Josh is checking a quote for GBP/USD, which is 1.41882. He wants to buy 5,000 USD, which means he would need to pay 3,524.11 GBP: (1/1.41882) * 5,000. Once the pair price loses 3 pips (30 points) and declines to 1.41852, Josh can sell off 5,000 USD to receive 3,524.85 GBP. The trade would bring Josh 74 pence. Not much, right? But assume the position is leveraged 1:100. Then Josh would gain 74 pounds. Most volatile currency pairs may gain and lose as much as 70 pips, allowing traders to get thousands of dollars on leveraged trades within a single trading day.
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Pip is the fourth digit in a quotation of a currency pair. The slightest move that can take place in a quotation is one point. The second-largest move that can take place in a quotation is one pip. One pip is equal to 5 points. It's essential to understand the difference between these two terms if you want to start trading. Understanding pips enables traders to read currency pairs, calculate profit or loss, and even find better trading conditions.
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