Forex Pips Explained

forex pips explainedMost professional forex traders think in terms of pips when it comes to considering their profits on any given day. The word "pip" stands for "percentage in point," or a percentage of the smallest currency unit. If you are trading dollars, euros, swiss francs (CHF) or most other currencies, this represents 0.0001, or 1/100th of a cent. If you are trading yen, this represents 0.01, or 1/100 of a yen.

 

How Do Pips Become Profits?

Because pips represent such a small number, many beginners to forex wonder how they can make a profit on such a small rise. Typically currency pairs don't go up or down by that many pips on any given day. The answer can be explained in one word: leverage. Typically, forex brokers will allow you to trade with a certain amount of leverage. With leverage of 100:1, for instance, you only need to put up $1,000 to purchase a lot worth $100,000.

The Value of a Pip

The value of a pip changes constantly depending on when you measure it and what currency pair you use. This is why traders typically speak in terms of pips rather than money profits. There are many pip value calculators online, but generally speaking, if you want to find the value of a pip simply divide the pip value (0.0001 with non-yen currency pairs, 0.01 with yen pairs) by the exchange rate. This is the value of a pip per dollar traded, so if you purchase a lot of currency worth $100,000, then multiply this number by 100,000 to get the value per pip on your trade.

Bringing It All Together

Back to the initial example using USD/CHF: If you purchase a lot worth $100,000 and put it all into USD/CHF, you may watch the price rise from 0.8411 to 0.8431. If you choose to sell at that point, you will have made a profit of 20 pips.

A pip in this case is worth (0.0001/0.8411) or 0.0001189. Multiply that number by the amount you're trading ($100,000) and you get $11.89 per pip, which makes the profit on the trade nearly $240. This is sizeable amount of money, considering that the currency pair only went up 20 hundredths of a cent!

Pips and Spread Price

The above discussion was slightly oversimplified, because it didn't take into account the spread price. Typically a spread price can be anywhere from 1 to 10 pips, depending on how often the pair is traded. A currency pair has to rise above the spread price to make a profit on the trade, meaning that the example above would actually require a price rise of 20 pips plus the spread (about 3 or 4 pips, typically) to yield the $240 profit.

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