The Pip: the Forex unit of measurement
You have seen previously that the exchange rate value between Euro and Dollar was expressed with a 5 digit number, one before, and four after the comma, for example 1.3020.
But how do we express the value changes of a currency exchange in Forex? Do we use the usual mathematical terms such as tenths, hundredths and thousandths? The answer is no, in Forex, unlike other markets where the unit of measurement is the tick, we use PIPS. Let’s talk about Pip measurement.
What is a pip in forex
The pip is the minimum price deviation of an exchange rate. We can say it’s the base unit of measurement of the movements in the foreign exchange market.
Let’s make an example to better illustrate the idea of pip unit:
If I say that EUR/USD is at 1.3020 + 1 pip, then EUR/USD is at 1.3021.
If, on the contrary, I say that the EUR/USD is at 1.3020 – 1 pips, then EUR/USD is at 1.3019.
So, as you understand, the pip is nothing more than the fourth decimal number after the comma.
So, in order to measure the quantity we have:
0.0001 = 1 pip;
0.0010 = 10 pips;
0.0100 = 100 pips;
0.1000 = 1000 pips.
The first thing to pay attention is not to confuse 1 pip with 0.1 pip (or tenth of a pip). Some brokers offer prices that are up to 5 decimal figures after the comma (much more accurate), but the pip always remains the fourth digit.
The fifth digit is instead commonly called “Pippete“, or tenth of a pip. Therefore:
– if we say that if EUR/USD moves from 1.3020 to 1.3021, the deviation is of 1 pip;
– if EUR/USD goes from 1.30201 to 1.30202, the deviation is of 0.1 pips; that is 0.00001 or one pippete.
Forex pips and its exceptions
Some currency pairs, among which the most famous are those with the Yen as the denominator (quote currency), have only 2 decimal figures after the comma. Therefore, the forex pip is no longer the fourth, but the second decimal place, and the pipette becomes the third.
Let’s examine the most representative two decimal place currency pair.
The currency pair Dollar against Yen is represented with only 2 digits after the comma, for example, USD/JPY 103.25.
In this case:
– if USD/JPY rose from 103.25 to 103.26, the deviation was of 1 pip;
– if USD/JPY rose from 103.251 to 103.252 deviation was 0.1 pips
What do we use forex PIPS for?
We have said that Pip acts as a measurement unit of the movements in the forex market.
The use of pips also facilitates communication between the parties, as it’s more convenient and quick to say that EUR/USD moved 150 pips, rather than saying that he moved 150 thousandths.
But we haven’t said yet what is the most important use. Pips are used by traders, or by any operator that make a transaction on the Forex market, to calculate the profits and losses of their operation.
Once he has decided how much a pip is worth for that operation, the trader has just to see how many pips has been able to accumulate, or otherwise to lose. However, when the transaction is closed, the gain or loss won’t be anything else but the multiplication of the pip value decided by the trader for the number of pips gained or lost.
Nothing could be easier.
This is one among the several elements that has driven hundreds of thousands of people to experiment Forex market, that is its ease of use. The other, as we’ll see now, is the fact that Forex market moves every day of many pips, or as they say in the jargon, is very volatile.
Pips variations generate volatility
The variations in terms of pips in the Forex market are very frequent and widespread.
This is one of the main reasons why this market is loved by many Trader, whether independent or not. If a financial instrument moves a lot and very often it’s said to be very volatile.
Very often we hear people and media talking about volatility in negative terms only, describing it as a strong component of risk. But the truth is that if an instrument is not volatile at all, it would make no sense to use it for trading or investing.
If the price of any goods, being it is stocks or exchange rate, does not move, it becomes very difficult to find investment and profit opportunities, both in the long term, and especially in the medium and short term.
The fact that in Forex the movements in terms of pips are frequent and widespread means that in this market the traders will have many occasions to try to take profit. It’s also true that the chances of losses will increases, but it’s precisely the high number of opportunities and possibilities that ensures that traders can use statistical and profitable methods to operate professionally.
As we will see later, in the Forex market a trader’s profit is calculated directly on the number of pips that can earn.
However, given the volatility, it’s obvious that traders must first be able to defend from possible movements against themselves, which means being able to manage the risk properly.