It’s difficult to overestimate the value of pips while trading in the foreign exchange (FX) market. The fundamental movement a currency pair might make in the market is represented by a pip, which stands for either “percentage in point” or “price interest point.” A pip is equivalent to 1/100 of a percentage point, or one basis point, in most currency pairings, such as the British pound/US dollar (GBP/USD), and pips are tallied in the fourth position after the decimal in price quotations. A pip is one percentage point in currency pairs involving the Japanese yen, and pips are tallied after the decimal in price quotations.
To promote international commerce and business, currencies must be exchanged. Such transactions, as well as wagers made by speculators hoping to profit from price movements in pairs of currencies, take place in the currency market. Pips are used to calculate the rates that forex market players pay when trading currencies.
Spreads, Pips, and Pipettes
When trading, the value of the pips for your deal might change based on your lot size. (A normal lot is 100,000 units, a mini lot is 10,000 units, and a micro lot is 1,000 units of a currency.)
The spread is the number of pips between the bid price (which is what the seller receives) and the ask price (which is what the buyer pays). Because most forex brokers do not charge fees on individual transactions, the spread is essentially how your broker earns money. When you purchase at the ask price (say, 0.9714) and sell at the bid price (say, 0.9711), the spread is kept by the broker (3 pips).
Account Pip Values in US Dollars
The pip value of many currency pairings is determined by the currency you selected to establish your forex trading account. If you establish an account in US dollars, the pip value for currency pairings where the US dollar is the second, or quote, currency will be $10 for a normal lot, $1 for a mini lot, and $0.10 for a micro lot. Only if the value of the US dollar climbed or decreased significantly—by more than 10%—would those pip values alter.
If your account is financed in US dollars, but the dollar isn’t the quote currency, you’d divide the typical pip value by the dollar-to-quote-currency conversion rate.
Other Account Currencies’ Pip Values
When a currency other than the US dollar is used to fund your account, the same pip value quantities apply when that currency is used as the quote currency. When the euro is the second currency in the pair, the pip value for a euro-denominated account will be 10 euros for a regular lot, 1 euro for a mini lot, and 0.10 euro for a micro lot. You would split the standard pip value by the exchange rate between the euro and the quote currency for pairs where the euro isn’t the quote currency.