It's difficult to undervalue the significance of pips when trading in the foreign exchange (FX) market. A pip, short for "price interest point" or "percentage in point," denotes the fundamental change that a currency pair can experience in the market. A pip is equivalent to 1/100 of a percentage point, or one basis point, for the majority of currency pairs, such as the British pound/U.S. dollar (GBP/USD), and it appears in price quotes after the decimal in the fourth position. A pip is one percentage point for currency pairs involving the Japanese yen, and pips are counted after the decimal in price quotes. To make international trade and business easier, currencies must be exchanged. Such transactions take place on the forex market, along with wagers placed by speculators who want to profit from changes in the exchange rates of different currencies. The rates that players in the forex market pay when making currency trades are determined using pip values.
Main points
- The rates that traders on the forex market will pay are determined per pip (percentage point).
- The value is dependent on the trading lot size (1,000 vs. 100,000 units, say).
- The pip value is based on the currency that was used to open the account.
- Brokers are paid a commission based on the percentage difference between the price a seller receives and the amount a buyer pays.
Spreads, piplets, and pips
Depending on your trading lot size, the value of the pips for your trade may change. (A "regular lot" of a certain currency is 100,000 pieces; a "mini lot" is 10,000 pieces; and a "micro lot" is 1,000 pieces.) The spread is the sum of the pip differences between the ask price (the amount the buyer pays) and the bid price (the price the seller receives). Since the majority of forex brokers do not charge commissions on individual trades, the spread is essentially how your broker generates money. The broker keeps the spread when a seller is selling at the bid price (say, 0.9711) and you are buying at the ask price (say, 0.9714). (3 pips). Several forex brokers quote prices to one decimal place after a pip. There is more flexibility in pricing and spreads thanks to these divisions of pips, known as pipettes.Values of account pip in US dollars
The pip value of many currency pairings is based on the currency you use to fund your forex trading account. If you open a U.S. dollar-denominated account, the pip value will be $10 for a normal lot, $1 for a mini lot, and $0.10 for a micro lot for currency pairs in which the U.S. dollar is the second, or quotation, currency. These pip values would only alter if the U.S. dollar's value changed noticeably—by more than 10%. You would split the typical pip value by the exchange rate between the dollar and the quote currency if your account was financed with U.S. dollars but the USD wasn't the quote currency. The pip value for a regular lot, for instance, is $7.51 ($10/1.3319), assuming the U.S. dollar/Canadian dollar (USD/CAD) conversion rate is 1.33119.Other Account Currencies' Pip Values
The same pip value amounts apply regardless of whether the currency that financed your account—not the U.S. dollar—is used as the quote currency. For instance, when the euro is the second currency in the pair, the pip value for a euro-denominated account will be 10 euros for a normal lot, 1 euro for a mini lot, and 0.10 euros for a micro lot. You would split the standard pip value by the exchange rate between the euro and the quote currency for pairs in which the euro isn't the quote currency.Trading Pip Movements
Consider that the bid price and ask price for the euro/British pound (EUR/GBP) pair are 0.8881 and 0.8884, respectively. You purchase a regular lot of euros at the ask price of 0.8884 because you anticipate the euro to strengthen versus the pound. The ask price is 0.8894 and the bid price is 0.8892 later in the trading day. You sell at the 0.8892 bid price. You made an 8 pip gain. You made 80 pounds on the trade, assuming your account was funded with pounds.