A Pip (Point in Percentage) is the unit of measure used by forex traders to express a tiny amount of changes in a currency pair. And it is measured in relation to underlying currency or quote. Most times, a pip refers to the 4th decimal point of a price which is equivalent to 1/100th of 1%. Let’s take a closer look at the importance of forex pips and how it works.
Why Are Pips Important in Forex Trading?
Forex pips signify the price movements that go on with currency pairs. When you consider how forex trading works off the price differences in 2 currencies, understanding pips is vital, irrespective of the strategy, indicators, and tips you prefer. Another significant benefit of pips is leverage. Leverage is the amount of money that a forex trader can use for trading but doesn’t actually own. Ultimately, leverage involves using borrowed money for forex trading.
Most forex brokerages offer quite a lot of leverage, which means you can easily open a big position. And when you trade with a lot of leverage, the difference one pip can make is significant – it can either make you an enormous profit or completely wipe you out.
How Does Pip Work
Let’s assume you open a long position on the currency pair at 1.0202. And now your currency pair is at 1.0204, which means that it has gained two pips. You have been trading higher and want to close your position. Your profits will depend on the size of your position.
As a forex trader, it is vital to understand that profits or losses are calculated in pips. Your pip value will be calculated by your brokerage, but it is important to understand how pips work as it can help you monitor fluctuations on a currency chart because this can affect your overall performance.
How to Calculate the Value of a Pip
Assuming you open a position on the EUR/USD quoted at 1.0202, you are required to pay 102,020 USD in return for 100,000 EUR. Now that the value of the pair increased by two pips, we can now translate that into money. To calculate the value of one pip, you need to divide one pip (0.0001) by the current exchange rate. Then multiply the result by the estimated amount of the trade.
((0.0001/1.0202) x 100,000) = 9.80 EUR is the value of one pip. So, your profit will be 19.60 EUR (9.80×2). Then you can convert 19.60 Euros back into USD based on our current new exchange rate. Keep in mind that one pip value will depend on the currency pairs since one pip value will be displayed in the currency of the variable/quote currency. And this will vary when you are trading different currency pairs.
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