In forex trading, “pips” refer to the smallest price movement that can be observed in the exchange rate of a currency pair. The term “pip” stands for “percentage in point” or “price interest point,” and it’s a standardized unit for measuring changes in currency pair prices.
Most currency pairs are quoted with four decimal places, except for the Japanese yen (JPY) pairs, which are typically quoted with two decimal places. Here’s how pips work:
For currency pairs with four decimal places (most major pairs):
- A pip is the smallest price change, which is usually the fourth decimal place. For example, if the EUR/USD exchange rate changes from 1.1234 to 1.1235, it has moved one pip.
For currency pairs with two decimal places (JPY pairs):
- In these pairs, a pip is the second decimal place. For instance, if the USD/JPY exchange rate changes from 110.20 to 110.21, it has moved one pip.
The concept of pips is essential for calculating profits and losses in forex trading. When you enter a trade and the price moves in your favor, you gain a certain number of pips. Conversely, if the price moves against you, you incur a loss in pips.
For example, if you buy EUR/USD at 1.1230 and sell it at 1.1250, you’ve gained 20 pips. Conversely, if you sell EUR/USD at 1.1250 and buy it back at 1.1230, you’ve also gained 20 pips.
Pips are crucial for determining the potential risk and reward in a trade, setting stop-loss and take-profit levels, and calculating position sizes. Traders often use the term “pip value” to refer to the monetary value of a single pip movement in a specific trade, as pip values can vary based on the size of the trade and the currency being traded.