Now I know to a lot of you this seems elementary but remember when you started trading, you also didn’t know what a Pip was. In fact, I’ll bet that there are people who call themselves traders but still can’t quite, exactly, explain what a Pip really is!
The first thing that you need to know is that Pip stands for Percentage in Points. That probably gives a good clue as to what a Pip is and what it is used for but you’re going to have to put on your thinking cap here and absorb this information carefully.
A Pip is used to measure the change in value between two currencies. Sounds simple right?
Let’s take a look at the current (26-09-2016) value of the GBPUSD currency pair. In this case, the GBP (Great British Pound) is the base currency as it is quoted first and the USD (United States Dollar) is the quote currency as it is quoted second. The current value or exchange rate is 1.2940 which means that you would currently receive 1.2940 USD for every GBP you have, if you were to exchange them. So if you had 50 GBP, you would receive 64.7 USD in exchange (50 * 1.2940).
Most brokers quote currency to the fourth decimal place. Every price increment at the fourth decimal point is equal to 1 Pip which means that 0.0001 is equal to 1 Pip.
I expect the GBPUSD price to move up to 1.2980 over the next few hours. Each increment of 0.0001 is 1 Pip and so this move in value would be 40 Pips in total. If we subtract 1.2940 from 1.2980 we get an answer of 0.0040 or 40 Pips.
Some Forex broker’s quote up to the fifth decimal place and this is what is referred to as a Pipette or fractional Pips. In other words the value of the GBPUSD would be quoted as 1.29401 and if it moved to 1.29402, that would be one Pipette, an increment of 0.00001 in the value.
You will also notice that some currency pairs are quoted to the third decimal place only. The JPY or Japanese Yen pairs are quoted to the third decimal place where each 0.001 increment in value is equal to 1 Pip.
Now we get to the fun part, calculating the monetary value of a Pip.
So it’s all good and well that you know what a pip is and, when looking at a currency, how many decimal places are equal to 1 Pip but what does that mean in terms of money?
The first thing you need to know is what your contract size or lot size is. When you trade 1.0 full lot on the forex market, you are trading 100,000 units of currency. Typically this used to be the only contract size that was available to trade a decade or two ago but as technology has become more efficient and competition has forced brokers to find ways of decreasing transaction costs, smaller lot sizes can be traded.
Most brokers now offer standard or full lots, mini lots and micro lots, as per the following:Full lot – 100,000 units
Mini lot – 10,000 units
Micro lot – 1,000 units
So in other words, if you traded a 0.13 lot size in Forex, you would be trading 13,000 units because that is equal to 1 mini lot (0.1) and 3 micro lots (0.03).
Now that you know how many units of currency you are trading, it is easy to calculate the value per Pip.
Let’s look at GBPUSD again where we know that price increments of 0.0001 are equal to 1 Pip. For this exercise, we will trade 1 mini lot (0.1 = 10,000 units) and assume that the exchange rate is 1.2940
Here is the formula:
(1 Pip in decimal places * trade size) / exchange rate = value per Pip
0.0001 * 10,000 = 1
1 / 1.2940 = 0.77279
Each Pip is equal to 0.773 GBP
If you placed a buy or long trade on GBPUSD with a mini lot (0.1) at 1.2940 and took profit at 1.2980, you would have made 40 Pips profit. Multiply that by the value per Pip and you have the profit in GBP:
0.773 * 40 = 30.92 GBP
But what if you are South African like I am or from another country and would like to convert that to your currency value?
The current GBPZAR exchange rate is 17.80 so I simply multiply that by my profit in GBP:
30.92 * 17.80 = 550.37 ZAR (South African Rand)
I can also calculate what each Pip is worth in ZAR
550.37 (profit) / 40 (Pips) = 13.76
Each Pip is equal to 13.76 ZAR