Currency exchange rates fluctuate in fractions of a dollar called Pip, where a Pip is an abbreviation for Price Interest Point (or Percentage in Point) and is the smallest price movement that a currency can make. Usually, it’s the last decimal of a quote, however, some brokers use a 5 decimal quotation system (and 3 decimal quotation system for the Yen pairs). In this case, the Pip is quoted on the 4th decimal (and 2nd decimal for the Yen pairs). When we’re using a 5 (and 3) decimal quotation system the last decimal is also known as pipettes or fractional pips.
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As an example, the smallest move the EUR/USD pair usually can make is $0.0001, or one basis point. When the currency exchange rate increases by one Pip, it means the Euro has strengthened against the US Dollar and if the currency exchange rates decreases by one Pip, and thus, the Euro has weakened against the US Dollar. Each pip movement in your favor or against you also represents a profit or a loss in your forex trade.
Pips are a valuable thing that can help us determine the distance to our Stop Loss order or Take Profit order or to determine the amount of risk taken.
What is the Pip value?
A Pip may have a minimal value on its own, but when trading large amounts of money, by the use of Leverage, its value can increase considerably. Ultimately the Pip value will tell us how much the smallest price movement it’s worth in a dollar amount and how much money we’re making or losing.
The Pip value of each of our trades is dependent on the volume of our transaction and the higher the number of Lots we’re trading, the higher the Pip value will be. Because each currency has its own relative value the Pip value will depend on that. Here are some explicit examples on how to calculate the Pip value.
We have two distinctive scenarios if the US Dollar is the Base currency like in the case of USD/CAD or USD/CHF than in order to calculate the Pip value, we need to use the next formula:
Pip Value = (One Pip / Exchange Rate) * Lot size
Example 1: If we buy 1 standard lot of USD/CHF that is trading at the 0.9885 level, then each pip move in our favor will be worth 10,11 USD.
Pip Value = (0.0001 / 0.9885) * 100.000 = 10,11 USD
The second scenario is when we have a currency pair that doesn’t contain the US Dollar – such as EUR/JPY or GBP/CHF. Such currency pairs are also known as cross currency and in order to calculate the Pip value we have to use the following formula:
Pip Value = [(One Pip / Exchange Rate) * Lot size]*Base Currency Exchange rate
Example 2: If we buy 1 standard lot of GBP/JPY that is trading at the 158.45 level, in order to calculate the pip value we’ll need the exchange rate of the Base currency, which in our case is the GBP/USD and we’ll use 1.4480 as our conversion exchange rate.
Pip Value = [(0.01 / 158.45) * 100.000] * 1.4480= 9,13 USD
If we trade 1 standard lot of GBP/JPY then each pip move in our favor will translate into 9,13 USD profit. If you’re not that great at math you don’t have to worry as most of the trading platforms offer you a pip calculator that will automatically display the pip value of your transaction.