March 9, 2010

Currency Trading – What Are Pips?

I have been reading about the new currency exchange program Pip Android and I started wondering if the beginner traders know what are those pips anyway. FX trading pips are a crucial part of forex trading that any trader must understand. They are the measure of movements in prices, and so of profit and loss. Brokers generally interpret pips into dollars and cents for you, or into the currency that your account is held in, if it isn’t US dollars. However, when comparing 2 trades with different position sizes it’s the profit or loss in pips that tells you more than the profit in dollars.

PIP stands for percentage in point. It is used as a measure of change in price. Spread is also measured in pips. The pip is the littlest part of the measured price of a quoted currency.

In practice, most currencies are quoted to four decimal places, e.g. 1.2315. In this example one pip is 0.0001 units of the quote currency. So if that price changes to 1.2316, the price has increased by one pip.

The japanese yen is the sole one of the major currencies that’s low enough in value to be usually quoted to 2 decimal places. So when the yen is the quote currency, one pip is 0.01 yen.

Some brokers are now beginning to quote the other major currencies to 5 decimal places. Logically this should mean that one pip would be 0.00001 currency units, but the potential there for confusion is massive, if a pip would be worth ten times as much with some brokers than with others. So it appears likely the pip will stay at 0.0001 units for most currencies.

Most traders record their profit and loss in Forex trading pips as well as in cash. This enables simple comparison of one trade with another so you can appraise a system. It also means that traders can debate their leads to a foreign exchange forum without revealing the dimensions of their account or their profits in greenbacks and cents.

If a trader tells you that they made a hundred pips profit, you do not learn anything about their finance situation. If they’re trading a pair like EUR/USD where the buck is the quote currency, one hundred pips profit would be $1,000 on a standard lot of $100,000 but only $10 on a $1,000 micro lot. To know the scale of one pip in dollars in this position multiply 0.0001 by the lot size.

To work out profit or loss from pips where the dollar is the quote currency, you simply need to grasp that one pip is $0.0001 x lot size. If you have another currency as the quote currency, the pip is naturally in that currency, and you can multiply by the exchange rate to know the pip worth in bucks.

All of this may seem confusing at first sight but anybody who starts trading will very soon understand what a pip means in practice. Currency trading pips are a useful tool for measuring and recording changes in price in currency trading.