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On your trading journey, you might have come across the term ‘Pip’ and wondered what pips are in trading. Perhaps you’ve also encountered its companions, ‘lots’ and ‘pipettes‘. These words that fly around in the financial markets are not just random words but essential concepts in trading.
This guide discusses this term, its significance, and how it shapes the forex market. We will first explain what a pip is and how it works, how to calculate it, and the difference between a pip and a pipette. So, this piece is critical for understanding forex trading and knowing exactly how the market works.
In This Guide
What is a Pip?
Forget about the question for a minute and remember your maths class. Do you remember expressing figures in decimals? It comes in handy in trading.
In trading, a ‘pip’ is simply a tiny price movement. Essentially, it’s the smallest shift in price that a financial security can make. Here, financial security refers to a currency pair because we don’t use pips in other instruments.
What are Pips in Forex Trading?
Each currency pair has a market price in the exchange of currencies, and this price changes due to many factors. Pips quantify these changes.
So, to put it simply:
A pip is the unit measure of the minimal price shift an exchange rate can experience.
But don’t confuse it with lots, which refers to the smallest unit of a financial instrument you can trade.
Calculation of Pips in Forex
You can quickly and easily determine the number of pips in a specific price, but the number depends on the forex pair you are trading.
For most currency pairs, a pip is typically equivalent to 1/100th of 1%.
For example, if the EUR/USD moves from 1.1060 to 1.1061, we say the USD has moved up ONE PIP. This one-point movement is equivalent to one pip.
But this argument doesn’t hold for relatively smaller currency pairs. Such pairs include the Japanese yen, e.g., USD/JPY. A pip is typically the second decimal place, meaning a move from 110.00 to 110.01 represents one pip.
Importance of Pips in Forex
Pips help us quantify our gains or losses in forex trading.
Since this type of forex trading involves substantial leverage, even a movement of a few pips can result in significant profit or loss. So, we monitor monitor pips closely, especially when setting stop-loss orders or take-profit levels.
What are Pips in Stock Trading?
As we already said, in trading we only associate pips with forex trading. However, a similar but not identical concept, often referred to as ticks, exists in stock trading.
A tick in stock trading is what a pip is in forex trading. It’s the minimum price movement of a trading instrument.
A tick can vary significantly between different stocks or commodities.
Differences Between Pips and Ticks
The difference between pips in forex and ticks in stock trading lies in their respective markets and the units they measure.
While pips are standardized to 0.0001 for most forex pairs, ticks can vary. For example, in the stock market, a tick might be $0.01, $0.10, or even $1.00, depending on the stock and the exchange it is traded on.
Relevance of Ticks in Stock Trading
In stock trading, ticks serve the purpose pips do in forex trading. You must understand how ticks work if you want to understand stock price movements and the stock’s liquidity. But we reserve this discussion for another article.
High-frequency traders and scalpers pay particular attention to ticks as they help them capitalize on small price movements within a short time.
How Are Pips Used?
Pips are an essential metric for traders to measure price changes, calculate profits and losses, and manage risk.
Here’s how we use pips in different aspects of trading:
Measuring Price Changes
Pips are a standardized way to measure price changes across different currency pairs. This uniformity lets us compare price movements easily and make informed trading decisions.
Calculating Profits and Losses
As a trader, your profit or loss from a trade is the number of pips you’ve gained or lost times the value of each pip. With this in mind, the calculation is straightforward and helps you assess your potential earnings or losses from a trade.
For instance, if you bought EUR/USD at 1.1000 and sold it at 1.1050, you have gained 50 pips. If the pip value is $10, your profit would be $500.
Setting Stop-Loss and Take-Profit Levels
We also use pips to set stop-loss and take-profit levels, which is critical for risk management.
If, for example, you place a stop-loss order 20 pips below the entry price, it will limit your loss if the market moves unfavourably. Similarly, if you set a take-profit order 50 pips above the entry price, it will lock in profits once the market reaches that level.
The Role of Pips in Trading Strategies
Whether day and swing trading or long-term investing, pips play a central role in trading strategies. Here’s how different strategies use pips:
Day Trading
Day traders rely on market movements to make quick profits within a single trading day. Using technical analysis, you can identify short-term trends and target small price changes. Closely monitoring pips allows you to pull through multiple trades and accumulate profits from each pip movement.
Swing Trading
Unlike day traders, swing traders hold their positions for days or weeks, waiting for opportunities to profit from the price swings. And in that case, pips tell you the entry and exit points. You can tell your likely profits and identify where to set your stop-loss orders to manage risk over an extended period.
Long-Term Investing
And it’s not only day traders that need pips. Even long-term investors pay attention to the market movements. If you are a long-term investor, you focus on broader trends rather than daily fluctuations. But with pip movements at the back of your hands, you can fine-tune your entry and exit points and maximise your investment returns.
Tools for Calculating Pips
Several tools and platforms assist traders in calculating pips and managing their trades effectively:
Trading Platforms
Most trading platforms, such as MetaTrader 4 (MT4) and MetaTrader 5 (MT5), have built-in tools to calculate pip values, profits, and losses. These platforms provide real-time data, charts, and technical indicators, making it easier to use pip movements and make informed decisions.
Pip Calculators
Online pip calculators are readily available. They allow traders to quickly determine the value of a pip for different currency pairs. By inputting the currency pair, trade size, and exchange rate, you can tell the pip value and your likely profit or loss from a trade.
Mobile Apps
Mobile trading apps also offer pip calculation tools, making it easier and more convenient to monitor your trades and manage your portfolios on the go. These apps often include features like price alerts, news updates, and charting tools to enhance trading efficiency.
Pips vs. Other Trading Metrics
Pips are a fundamental metric in trading. But they are not the only measure traders use. Other equally important metrics include:
Points
In some markets, we measure price movements in points instead of pips. A point is similar to a pip, but we use it in the context of stock indices and futures contracts.
For example, a one-point move in the S&P 500 index might be equivalent to a price change of $1.
Basis Points
Another metric is basis points (bps), which describe changes in interest rates or yields. It’s particularly used in the bond and interest rate markets.
One basis point equals 0.01%. For example, if a bond yield increases from 2.00% to 2.50%, it has risen by 50 basis points.
Percentage Change
Traders and investors also use percentage change to measure the difference in price over a specific period. This metric is useful when comparing the performance of different assets and analysing the overall market trend.
FAQs
How much is $1 in pips?
The value of $1 in pips varies based on the currency pair and trade size. For example, with USD as the quote currency, one pip is typically $10 in a standard lot (100,000 units), while in a mini lot (10,000 units), it is $1. Further, in a micro lot (1,000 units), it is $0.10.
How do pips affect my trading strategy?
Pips help you set stop-loss and take-profit levels and evaluate the risk-reward ratio of each trade. By understanding pip values, you can better manage your risk and set appropriate trade sizes relative to your account balance.
Can the value of a pip change during a trade?
The pip value can change during a trade due to fluctuations in exchange rates, especially for currency pairs with high volatility or large trade amounts. The value may also vary based on account types and leverage settings. Stay alert to these changes.
How do brokers display pips on trading platforms?
Brokers display pips on trading platforms as the fourth decimal place in most currency pairs (e.g., 0.0001) and the second decimal place in currency pairs involving the Japanese yen (e.g., 0.01).
How can I track pip movements in real time?
Trading platforms provide real-time pip movement tools, including charts, price feeds, customizable alerts, and third-party tools to help you monitor significant price changes and market conditions.
Conclusion
Your journey to understanding and quantifying price movements in forex trading starts with understanding the concept of pips. Pips provide a standardized way to measure currency pair price movements and manage risk. If integrated into various trading strategies and used with other trading tools, they help us make informed decisions. While primarily for forex, similar concepts like ticks and basis points apply to stock trading and other financial markets. Try using pips with other trading metrics to improve your market analysis.