An Overview of Pips in Forex
People around the world are drawn to the forex trade, for a number of different reasons. Some like it because it offers trading at all hours during the week, whereas stock markets open and close daily. Some look to forex because it can appear to be significantly simpler than stock trading. And others simply want an alternative way to invest. Ultimately though, the forex trade’s widespread appeal has led it to become the biggest investment market in the world, with daily trading volume over $6.6 trillion, according to a Bloomberg piece written in 2019.
What this means is that there are constantly new traders entering the world of forex. And while it’s a fairly straightforward market, there are a few things all of those new traders need to understand before they get started. One of those things is the importance of a “pip.”
What is a Pip?
‘What is a Pip?’ by FXCM defines a “pip” in forex as an acronym that stands for “Price Interest Point.” It further explains that this refers to “the measurement of the price change for a currency pair expressed in decimal points” — and specifically, the “smallest tradable quantity quoted in the market.” To use some examples, this means that in a currency pair expressed in two decimal points, a pip is any shift in value amounting to 0.01. If a pair is expressed to four decimals, a pip is equal to a change in value of 0.0001, and so on. So, if the value of USD/EUR moves from 0.9145 to 0.9146, it has gone up by a pip.
What Are Pips For?
Because the forex market involves fractions of currency amounts and high-volume trades, pips are essentially used as theoretical units, or simplified expressions of value. These expressions work such that a pip assumes a value based on the currency pair at hand and the value of the exchange rate at a given point. Specifically, a pip’s value is its position divided by the exchange rate. Using the example above then, if the exchange rate of USD/EUR starts at 0.9145, the value of a pip is 0.0001 divided by 0.9145 (which equals 0.00010935).
Understanding this, one can express forex gains and losses as pips, and then calculate the value. So, if a trader buys USD/EUR at 0.9145 and sells it at 0.9165, he or she has gained 20 pips on the trade (which can then be understood as a value relating to the selling exchange rate).
To fully understand pips and how they’re used, you’ll also need to understand a few additional terms as well. The following tend to come up in discussions and dealings involving pips:
- Ask Price – This is what a broker is selling a currency pair for. So, using the same example of the USD/EUR pairing from above, we can say that an ask price might be 0.9145. The ask price will always be higher than the bid price (what you can sell the pair to the broker to), so that the broker can make a profit.
- Bid Price – This is the price you sell a pair to the broker to, and it is typically lower by just a few pips. So for instance, the bid price of USD/EUR in this example might be 0.9140. That would mean that the pair could be listed as 0.9140/45, with the five-pip difference being the “spread” between bid and asking price.
- Handle – The handle is essentially the value listing of a currency pair up to the tens of pips. So, if USD/EUR is at 0.9145, the “handle” is 0.91.
- Dealing Price – The dealing price is essentially what’s left over in pips after the handle in a given value. Given the same example in which the handle for USD/EUR at 0.9145 is 0.91, the dealing price is 45.
Getting a feel for pips and how they factor into forex ultimately takes some time and practice. But this overview should help you understand the fundamental meaning and use of these elements of the forex trade.
Beyond pips, there are a number of other things you’ll need to understand as well before you’re ready to start trading. You’ll need to compare brokers and devise a trading strategy. You’ll want to read up on the most commonly traded currency pairs and when the best times are to trade them. And these days, you may even want to read up on the cutting edge of forex and some of the tech that may soon be prevalent in the market, with Blockchain Magazine having recently reported that the Japanese Holdings Company has joined an increasingly large list of forex entities using blockchain. But if you’re just getting started, it’s best to take things one step at a time, and understanding pips is a good place to start.