This article defines a forex pip for the beginning foreign currency exchange trader. It explains how a pip reflects currency strength or weakness and gives an easy to follow example. Calculations provided are based on the US Dollar.
A pip in forex trading is a “percentage in point” or a “price interest point”. It is the smallest measure of price movement between two currencies in the foreign exchange currency market. Six of the seven majors – the US Dollar (USD), the Euro (EUR), the British Pound Sterling (GBP), the Swiss Franc (CHF), the Australian Dollar (AUD) and the Canadian Dollar (CAD) – measure a pip as 0.0001 of one cent. The seventh major, the Japanese Yen, (JPY) measures a pip as 0.01 of one cent.
How Does a Pip Reflect the Strength or Weakness of a Currency?
Currencies are always quoted in pairs in the forex market. The first currency listed in the quote is known as the “base currency”. The base currency is always equal to 1.0000, unless the currency is the Japanese Yen, in which case it is equal to 1.00.
The second currency listed in the quote is the “quote currency”. A currency pair shown as EUR/USD, identifies the Euro as the base currency and the US Dollar as the quote currency. A currency pair shown as EUR/USD 1.2900 tells the foreign exchange currency trader that 1.000 Euro is equal to 1.2900 US Dollars. This means that it takes 1.2700 US Dollars to buy one Euro.
If a quote currency, in this example the US Dollar, increases by one pip and is shown as EUR/USD 1.2901, one Euro is now valued at 1.2901 US Dollars. Forex traders will know that the US Dollar has now decreased in value against the Euro. Now, it takes 1.2901 US Dollars to buy one Euro.
When the quote increases by 100 pips to 1.3000, it takes 1.3000 US Dollars to buy a Euro. In both of these examples, the US Dollar has weakened against the Euro. The forex market, however, doesn’t trade currencies one bill against another. Currencies are traded in lots of 100,000.
What is the Dollar Value of a Forex Pip?
When an investor buys one currency in the pair he or she simultaneously sells the other. An investor who thinks that the value of the Euro will continue to strengthen against the US Dollar will buy Euros and sell US Dollars.
If the quote increases one pip from EUR/USD 1.2900 to EUR/USD 1.2901, the forex trader, who is now long Euros, will have earned $10.00 (0.0001 x 100,000 = $10.00). Should the Euro increase 10 pips from 1.2900 to 1.2910, the result is an increase of $100.00.
The pip values shown here are in US Dollars. To convert a $10.00 pip value to another currency, foreign exchange currency traders can visit any online currency converter to get the current exchange rate for his or her home currency.
Forex Trading: What Is a Forex Pip?