What is a Pip?
In order to be successful in any business it’s important to understand
the basics concepts that fuel the business. In any business there are
always terms and a special language that must be understood to be
successful. In the forex trading business that is definitely the case.
The foreign exchange business is filled with words that have their own
meaning. Words like trends, trading pairs, trendlines, technical
indicators, charts, lots, spread and forex pips are used in forex
trading to denote activity of some kind within the currency trading
market.
In the fx trading world, a pip is the smallest increment in a
trading pair. Pip is short for percentage in point. A forex pip is the
term used to denote movement between a currency pair. In order to
measure how much money you’re making in the online forex trading
market, it’s essential to understand that a forex pip means percentage
in point. Once the forex pip is understood, the forex trader can track
and measure the amount of money that can be considered a profit or a
loss from currency trading transaction.
Prices in the foreign exchange market are quoted to the fourth decimal
point. The currency pair Euro and the United States dollar would be
written EUR/USD and the bid for that forex pair might be 1.1914 and the
offer could be 1.1918. In this example the currency spread is 4 forex
pips, which is the difference between those two values. The only
currency that is not quoted in a four decimal figure is the Japanese
Yen or JPY. It is only quoted in two decimals.
In order to understand how forex pips are translated into U.S. dollar
gains, it should be understood that the US dollar can be the base
currency or the counter/quote currency. If the US dollar is the quote
currency in the currency pair GBP/USD, which is the British pound and
the U.S. dollar currency pair, the forex pip will always be worth ten
dollars because the US dollar is the quote price. If there is a forex
pip movement of five pips in your favor, then the value of that or
profit from that currency movement is fifty dollars. The roles can be
reversed so that the US dollar is the base and the pound is the quote.
That currency pair would be listed USD/GBP which equals a value of
0.5170 which means that the US dollar is worth 0.5170 UK pounds.
If there is an increase of one forex pip, the value of the US
dollar would be 0.5171 UK pounds. The standard interbank lot size is
100,000 in forex trading so the original US dollar has a forex value of
100,000 dollars and the UK pound value is 517,000 pounds. When the
forex pip increases by 1, the value of the UK pound increase to 517,100
pounds, which means the US dollar value is now; 100 ÷ 0.5171 or 193.39
US dollars.
The US dollar as a quote price will always have a value of ten dollars
for a standard trading lot, but the forex pip value will change with
the market price when the dollar is the base currency in the
transaction.
Understanding the forex pip, the forex spread and the forex point is
crucial in the foreign exchange market as well as your own strategy. Without that foundation, the
chance to make a profit in forex trading is a dream that could turn
into a nightmare. The basic principles of currency trading are not
difficult to learn, but in order to be successful in the fast moving
world of currency trading every aspect of the business should be
researched and studied. That strategy along with patience and focus
will produce the profitable results you expect.