Pip Definition – Investopedia

What Is a Pip?

“Pip” is an acronym for percentage in point or price interest point. A pip is the smallest whole unit price move that an exchange rate can make, based on forex market convention.

Most currency pairs are priced out to four decimal places and a single pip is in the last (fourth) decimal place. A pip is thus equivalent to 1/100 of 1% or one basis point.

For example, the smallest whole unit move the USD/CAD currency pair can make is $0.0001 or one basis point.

Key Takeaways

  • Forex currency pairs are quoted in terms of pips, short for percentage in points.
  • In practical terms, a pip is one-hundredth of one percent (1/100 x .01) and appears in the fourth decimal place (0.0001).
  • A pip equals one basis point.
  • The bid-ask spread of a forex quote is measured in pips.
  • The Japanese yen is an exception because its exchange rate extends only two decimal places past the decimal point, not four.

What Is A Pip?

Understanding Pips

A pip is a basic concept of foreign exchange (forex). Forex traders buy and sell a currency whose value is expressed in relation to another currency. Quotes for these forex pairs appear as bid and ask spreads that are accurate to four decimal places.

Movement in the exchange rate is measured by pips. Since most currency pairs are quoted to a maximum of four decimal places, the smallest whole unit change for these pairs is one pip.

Calculating Pip Value

The value of a pip depends on the currency pair, the exchange rate and the trade value. When your forex account is funded with U.S. dollars and USD is the second of the pair (or the quote currency), such as with the EUR/USD pair, the pip is fixed at .0001.

In this case, the value of one pip is calculated by multiplying the trade value (or lot size) by 0.0001. So, for the EUR/USD pair, multiply a trade value of, say, 10,000 euros by .0001. The pip value is $1. If you bought 10,000 euros against the dollar at 1.0801 and sold at 1.0811, you’d make a profit of 10 pips or $10.

On the other hand, when the USD is the first of the pair (or the base currency), such as with the USD/CAD pair, the pip value also involves the exchange rate. Divide the size of a pip by the exchange rate and then multiply by the trade value.

For example, .0001 divided by a USD/CAD exchange rate of 1.2829 and then multiplied by a standard lot size of 100,000 results in a pip value of $7.79. If you bought 100,000 USD against the Canadian dollar at 1.2829 and sold at 1.2830, you’d make a profit of 1 pip or $7.79.

Japanese yen (JPY) pairs are quoted with 2 decimal places, marking a notable exception to the four decimal place rule. For currency pairs such as the EUR/JPY and USD/JPY, the value of a pip is 1/100 divided by the exchange rate. For example, if the EUR/JPY is quoted as 132.62, one pip is 1/100 ÷ 132.62 = 0.0000754. With a lot size of 100,000 euros, the value of one pip (in USD) would be $7.54.

Fractional pips are smaller than pips and, thus, a more precise measurement. They appear as a superscript numeral at the end of a quoted exchange rate. A fractional pip is 1/10 of a pip.

Pips and Profitability

The movement of the exchange rate of a currency pair determines whether a trader makes a profit or loss at the end of the day. A trader who buys the EUR/USD will profit if the euro increases in value relative to the U.S. dollar. If the trader bought the euro for 1.1835 and exited the trade at 1.1901, they would make 66 pips on the trade (1.1901 – 1.1835).

Now, let’s consider a trader who buys the Japanese Yen by selling the USD/JPY pair at 112.06. The trader loses 3 pips on the trade if they close out the position at 112.09. They profit by 5 pips if they close it out at 112.01.

While the difference may look small, in the multi-trillion dollar foreign exchange market, gains and losses can add up quickly. For example, on a $10 million position that closed at 112.01, the trader would make ¥500,000. In U.S. dollars, that’s $4,463.89 ( ¥500,000/112.01).

Real-World Examples of Pip

A combination of hyperinflation and devaluation can push exchange rates to the point where they become unmanageable. In addition to impacting consumers who are forced to carry large amounts of cash, this can make trading unmanageable and the concept of a pip loses meaning.

A well-known historical example of this took place in Germany’s Weimar Republic, when the exchange rate collapsed from its pre-World War I level of 4.2 marks per dollar to 4.2 trillion marks per dollar in November 1923.

Another case in point is the Turkish lira, which reached a level of 1.6 million per dollar in 2001, which many trading systems could not accommodate. The government eliminated six zeros from the exchange rate and renamed it the new Turkish lira. As of January 2021, the average exchange rate stands at a more reasonable 7.3 lira per dollar.

What’s a Pip?

A pip is the smallest whole unit measurement of the difference between the bid and ask spread in a foreign exchange quote. A pip equals 1/100 of 1%, or .0001. Thus, the forex quote extends out to four decimal places. Smaller price increments are measured by fractional pips. A fractional pip is 1/10 of a pip.

How Are Pips Used?

They are a part of a currency pair’s exchange rate market quote. Pips represent the change in the quote and value of a position in the market you may have taken. Say, hypothetically, you bought a currency pair for 1.1356 and sold it for 1.1360. You made 4 pips on your trade. You’d have to then calculate the value of a single pip and multiply that by your lot size for the dollar value of your profit.

Does the Japanese Yen Forex Rate Use Pips?

Yes, it does. However, the yen is an exception. A quote for the yen normally extends two decimal places past the decimal point. So, a single whole unit pip is .01 rather than the .0001 for other currency pairs.

Leave a Reply

Your email address will not be published.