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When you’re trading forex, you’ll likely hear the term “PIP” tossed around quite a bit. But what is a PIP, exactly? And more importantly, how do you use it to your advantage in forex trading?
What is PIP?
PIP stands for Percentage in Point. It is the smallest unit that can be used to measure forex prices. PIPs are one-hundredth of a % or 0.0001 in decimal format. For this reason, it is also known as the pipette in some circles.
The exchange rate specifies how much one currency costs in another currency. For instance, if the current exchange rate shows 1 GBP = $1.50, then it means that you can get $1.50 for every British Pound (GBP) you own and vice versa – if your neighbour wants to buy a pound, he will have to give you $1.50 worth of US dollars for each British pound that he wishes to purchase.
The value of a pip is the same for all currency pairs. For example, if you trade AUD/USD and USD/JPY, the value of a pip will be the same for both currency pairs.
A PIP is simply the slightest price change that can occur in a currency pair. It’s usually represented by the last two digits of the currency pair rate. For example, if AUD/USD moves from 0.7175 to 0.7176, that would mean a PIP movement of 1. In other words, the value of the Australian Dollar increased by 1/100th against the US dollar.
Why is understanding PIPs critical?
Because it allows you to gauge how much profit or loss you could potentially make on a trade. Let’s say you buy 100,000 Euros at 1.1150, with the expectation that the Euro will continue to appreciate against the US dollar. If the EUR/USD rate then moves up to 1.1175, you would have made a profit of 25 pips (1.1175-1.1150). Conversely, if the EUR/USD rate moves down to 1.1125, you would have incurred a loss of 25 pips (1.1125-1.1150).
Knowing how to read and interpret PIP movements is essential for any forex trader. But it’s also important to remember that PIPs are only relevant when trading with the major currencies. Currencies traded on the minor exchanges are less liquid, which means they’re more susceptible to extreme price movements. As a result, their PIP values are more significant in both directions. For example, if you see that EUR/HUF moves from 269.50 up to 269.51, that’s equivalent to a 2-pip movement – much bigger than the typical 1-pip move for major currencies.
PIP movements are not set in stone
It’s also important to realise that PIP movements are not set in stone – they change throughout the day based on market conditions and volatility levels. You’ll often hear traders talk about “PIP spikes” or sudden increases in the value of a currency pair over a brief period. These spikes can occur for several reasons, such as news announcements or geopolitical events, and can result in quick profits (or losses) for traders who are caught off guard.
PIPs are essential for forex trading because they allow traders to calculate their profits and losses. It’s done by multiplying the number of pips earned or lost by the size of the trade.
PIP values do not always increase if the forex market favours traders. The opposite also applies – when the forex market moves against you, PIPs can decrease even if they are positive. It may explain why some novice traders often think that PIPs increase value just because their trade went well.
So how can you use PIPs to your advantage when trading forex?
The first step is to familiarise yourself with the various currency pairs and their respective PIP values. It will give you a good idea of which pairs offer the best opportunities for profit (and which ones to avoid). You’ll also need to be constantly monitoring the markets so that you can jump on any PIP spikes that may occur.
It’s essential to remember that PIPs should only be one part of your overall trading strategy. While they can be instrumental in determining profit potential, they’re not the only factor you need to consider when trading forex. If you want to give yourself the best chance for success, your focus should include market sentiment, fundamental analysis and technical indicators.