The terminologies “pips” and “lots” are two very important words when it comes to forex trading. They will be used time and again when you are already doing your own currency trading. In fact, we have already made mention of these words in the previous chapters. Calculating for pips is quite important that it has become a required knowledge for all forex traders. As they say, a trader will be successful if he knows how to do 3 things. Those 3 things are to “make pips,” “keep pips,” and to repeat the first two. So what then is a “pip”?
The currencies’ most common increment is called a pip. It is the currencies’ smallest price movement. You have one pip if the EUR/USD moves from 1.2245 to 1.2246. It is the quotation’s last decimal place. A pip is how you measure profit or loss. Calculating the value of a pip per currency is important since each currency has its own value. Most currency pair rates reach up to 4 decimal places. There are however, some with only two decimal places.
Let us again illustrate by using examples. With a currency pair wherein the US dollar is the first one quoted, say USD/JPY, at a rate of 119.90. For USD/JPY, 0.01 is one pip. A pip value is equal to the pip divided by the exchange rate. Therefore, 0.01 divided by 119.90 is equal to 0.0000834. Thus, the pip value is 0.0000834. Though this value may seem too little given the number of decimal points, you will be able to appreciate it later when you start computing these decimal points according to lots. The same computation would of course apply with other currency pairs. To cite another example, USD/CAD with 1.4910 as the exchange rate is calculated as 0.0001 (the pip) divided by 1.4910 (exchange rate) is equal to 0.00006707 (pip value).
The above examples however are only for forex quotes where the US dollar is the base currency. If the base currency is not the U.S. dollar, the same computation applies but an additional step will be needed. To illustrate, let us cite more examples.
We do the same computation above; let us say for EUR/USD at a rate of 1.2400. So again, the pip, which is 0.0001 divided by the exchange rate 1.2400 is equal to EUR 0.00008065 (the pip value). However, since there is a need to get back to the US dollar, another step should be done. You would need to multiply the pip value, which is EUR 0.00008065 with the exchange rate, which is 1.2400. This would give you 0.0001. The same goes for other pair not starting with a U.S. dollar.
Looks very complicated? Is it too complex to understand? The good news is, you do not really need to memorize everything and you will not have to constantly be computing for these things when trading. Your broker will work this out for you. The reason these computations are being imparted to you is for you to know how these things work. This way, you have an idea where your broker gets his computations.
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