What is a PIP?

The Percentage Interest Point or PIP is the smallest unit that measures the change in the price of a currency. Pricing in forex is usually done to 4 decimal places, or in the case of the Yen crosses, 2 decimal places. One PIP is the equivalent of 1/1000^th of a point, or 0.0001 points. For Yen crosses, one pip is equivalent to 0.01 points.

These days, more and more brokers are trying to get their traders more precise pricing for currency trades so as to reduce spread costs and also allow for faster and more precise algorithmic executions. This new pricing system has added a 5^th decimal place to conventional currency pairs and a 3^rd decimal place to Yen crosses. The extra decimal places, also known as pipettes, are only 1/10^th of the value of the regular pip.

Application of the PIP in Forex

For a forex trader, the concept of the pip has relevance in the following applications:

a)      Determination of pip value in a trade context

b)      Understanding the pip value for different currency pairs

Determining the value of the pip is important as it tells the trader about the positive or negative value of a potential trade. It is also an integral part of risk management; knowing in monetary terms how much a Stop Loss or Take Profit would translate into when a trade is closed in profit or loss positions.

In addition to knowing the monetary value of a pip, it is good that traders also know how many pips they will have to pay in spreads when trading a particular currency pair. There are currency pairs with a spread of 2 pips, and some with spreads as much as 50 pips. How much is a trade in an exotic pair with 50 pips in spread going to cost to initiate? Can a particular account size handle it?

These are all various aspects of the application of knowledge about the pip.

Pip Monetary Value of Currency Pairs

Each currency pair has its own monetary value for a pip change in price.

–          For the AUDUSD, GBPUSD and NZDUSD currency pairs, the pip value for a USD-denominated account is 10 times the exchange rate of these currency pairs.

–          For the USDJPY, the pip value for a USD-denominated account is 1000 divided by the exchange rate of the USDJPY

For an exchange rate which features the USD as base currency and other currency apart from the Yen as counter currency (e.g. USD/CAD), the pip value = change in price of counter currency X exchange rate ratio.

Example 1: If a trader wants to buy 1 Standard Lot of the USDCAD, what would be the monetary value of a change in price of the currency pair by one pip?

The exchange rate of the USD to the Canadian Dollar as at the time of writing this is 1.2760. So the formula for calculating the pip value of the USDCAD is:

[.0001 CAD] x [1 USD/1.2760 CAD]

The formula can also be expressed as:

[(.0001 CAD) / (1.2760 CAD)] x 1 USD = 0.00007840 USD per unit of currency traded.

So if we traded 100,000 units of USD/CAD (Standard Lot), then change in exchange rate of 1 pip is: 100,000 units x 0.0000784 USD/unit, or $7.84 per unit.

Example 2: A trader wants to set 50 pips as Stop Loss and 100 pips as Take Profit on a GBPJPY trade. His account is USD-denominated. How much will this translate into in his account currency?

Knowing the monetary value of a pip in an active trade is also necessary when used in calculating the stop loss or profit targets. After all, you need to know in raw cash how much you stand to lose or gain in a trade when it is all over.

Let us assume that the exchange rate of the GBPJPY at the time of writing this is 179.10. The Yen crosses carry only 2 decimal places.

The formula for calculating the value of a pip for a Yen cross such as this is:

(The value change in counter currency) times the exchange rate ratio or

[(.01 JPY) / (179.10 JPY)] x 1 GBP = 0.0000558 GBP

So if a trader buys 10,000 units (1 mini-lot), the value of one pip is 0.558 GBP.

If the trader’s account is USD-denominated, then the conversion of this value into USD must be done using the exchange rate of the British Pound to the US Dollar. Current exchange rate is 1.4762.

Formula is:

.558 GBP per pip / (1 GBP/1.4762 USD)

OR

[(.558 GBP) / (1 GBP)] x (1.4762 USD) = 0.8237 or simply 0.82 USD per one pip move for a 1 mini-lot trade.

If such a trader were to set a 50 pip stop loss and a 100 pip profit target, then the value of these targets for a 1-minilot trade size would be $41 for the stop loss, and $82 for the profit target.

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