It all begins with this simple question: “What is a pip?” and it continues “How can pips change your fortune?”Simple Answer: a pip is the tiniest change in a currency pair at a forex party, usually the last decimal point of the pair’s price. At your broker’s forex party platform, a pip is the final digit of the largest numbers at your face.
Now don’t get fooled by their small size. A pip may have minimal value on its own, but when trading large amounts of money, its value can totally kick butts. If you add a large leverage to your trade, the originally tiny pip can become humongous.
That is why in the forex world, we usually calculate our profit and losses based on pips. It just makes the whole process much easier, because just like me, most of us hate calculating stuff. So in most trading platforms you can find a “pip calculator” that magically calculates your trade’s pip value in the matter of seconds. That’s just how cool forex is.
But just for the heck of it (and also to better understand the whole pip thing), let’s manually calculate a pip value and pips earned at a trade. Say you want to buy 10,000 worth of Canadian dollars. At the forex party that you’re at, USD/CAD is quoted at 1.1111.
Challenge: Read the number above out loud in a public place: One point one one one one. I bet you feel better now.
Back to work. USD/CAD= 1.1111
Now you want to see how much you would have to pay in US dollar to buy 10,000 Canadian dollars. Don’t be scared. They are just numbers. Okay… Let’s do it together, my brilliant newbie traders. Bring out your calculator.
(1/1.1111)* $10,000 = 9,000.09.
You have to pay 9,000.09 US dollars to get 10,000 Canadian dollars.
So you are at the forex party, debating whether or not you want to enter the game while enjoy your coffee, and before you know it, the currency pair makes a move and you see a one-pip increase to 1.1112. In the geeky forex world, this means that the US dollar appreciated relative to the Canadian dollar.
Hah. Now you have to pay 8,999.28 US dollars to buy 10,000 Canadian dollars! You now can pay 81 cents less!! Yay!
But, wait a minute, 81 cents doesn’t even sound like a big difference… Did you check how much your position was leveraged? 50 times? Now that’s what I’m talking about.
With a 50 times leverage, that single pip equals 40 dollars and 50 cents.
0.81*50 = 40.50
And you know that the naughty currency pairs can easily move like 100 pips a day. That means a $10,000 position, at a 50:1 leverage, can see gains or losses of $4,000 throughout the trading day. Cool stuff huh?
To conclude, pips are the most basic unit of measure in Forex trading. And since you already know that learning the basics step-by-step is very important in forex trading, you need to understand how a pip value relates to your positions in every forex party that you attend.