Pips and Pip value

We have discussed in our previous video the trading sizes, and now we will discuss how we measure the change in the value of a trading instrument. 

In FX pairs the smallest amount of change in a currency pair is called a pip. So should an exchange rate move that movement is measured in pips. Actually the word pip, many analysts tend to claim that is an acronym and derives for the words “percentage in a percentage”. That’s why the pip is placed in the fourth decimal place and equals a change of 0.0001.

For example, if EUR/USD is priced at 1.1110 today and tomorrow is priced at 1.1121, that would mean that the pair moved upwards by 11 pips. 

Yen crosses on the other hand are an exception and a pip is displayed in only two decimal places hence one pip in these crosses equals 0.01.

Also, when discussing the pip we have to mention the fractional pip or, as some traders call it, a pipette, not to be confused with the laboratory instrument. A pipette is a fraction of a pip, actually a tenth of a pip and is placed on the fifth decimal place to provide more accuracy when calculating profits or losses.

However, a pip also has value that can be expressed in monetary terms. But this depends on three factors: the currency pair, the exchange rate and the size of the trade.

Lets’ have a look how these three factors interlink and produce the value of a pip in monetary terms.

For example, if I trade a full lot in EUR/USD then the change of one pip would equal $10. Specifically, if I initiate a long position in EUR/USD, which is currently trading at 1.1100 and then moves up to 1.1200 that would mean that the pair moved upwards by 100 pips and at the same time I would have won US $1000. Why? Because my position was of a size of €100,000 and the exchange rate went up by 0.0100 or if you prefer 100 pips, that my profit would be equal to the position size time the change of the exchange rate i.e. 100,0000*0.0100=$1000. Hence my profit equals $1000 and given that the movement of the pair was of 100 pips that would mean that each pip of the EUR/USD’s movement equals $10.

Note how the position size is mentioned in the base currency yet the pip value is mentioned in the variable currency.

Hence, if we put it in an equation that would be Pip value=Pip size * Position Size and for each pip of a full lot of EUR/USD that would €100,000*0.0001=$10.

If I want to convert the pip value back to the base currency, then I only have to divide the Pip value by the current exchange rate of the preferred exchanged rate.

Hence, this will mean that Pip value = (Pip size * Position size) / (Ex. rate). For example, if my account is in pounds and I want to know the pip value in pounds, I change the dollar pip value using the GBP/USD rate. So, for 1 lot: $10 / (GBP/USD)

If you make a couple of repetitions with different exchange rates, it will enable you to make the calculations of the change in an exchange rate in pips.

Please note that Pips apply only in the FX market. The change in value of stocks, gold and oil are measured in dollars and cents, while the change in value of indexes especially for shares is measured in ticks.

In the next video, we will discuss what kind of orders there are for a trader to start trading.