What is a PIP in Forex?
The Forex market is rife with a fair amount of complex jargon and abbreviations. However, it is relatively easier to understand it, than it seems. It is also imperative to do so, as understanding their meaning can allow you to trade successfully in the Forex market. A ‘PIP’ stands for percentage in point. It is the smallest price change that any given exchange can make, and an increase or decrease in PIP’s represent the profit or loss you make while trading in the Forex market.
Understanding the PIP
The PIP is the slightest shift in the last decimal point that changes in the market every day. To illustrate further, the US dollar could be a good example. When currencies are quoted in the international Forex market, they are quoted up to four decimal places, an example of it is $5.4321. In this case, the change in the digit ‘1’ is considered as the PIP change. If the USD changed from $5.4321 to $5.4322, it is an ostensible increase in the PIP by one. Similarly, if it were to decrease to $5.4320, the PIP would have reduced by one point.
The Japanese Yen, is the only exception to the four decimal point rule. In the case of the Yen, the quote is only up to 2 places, for instance ¥43.21. However, the change in the last digit after the decimal point will be considered as the rise or fall of the PIP in this case.
How does a PIP work?
While calculating a PIP it is always important to understand that whenever any currency is traded, it is always traded as a couple against each other. For example, the EUR and USD, are commonly traded together. To calculate the PIP there is some basic math involved. In the Euro-USD example let us take 5.4321 as the exchange rate. In this case if the PIP = 0.0001, which indicates the change in PIP value, you then have to divide 0.0001 by 5.4321, which results in the value 0.0000184 Euros. The PIP value is defined as this value.
In terms of how it works in the market it can be better understood with a deal example. If you wish to sell 100,000 Euros in the market, the PIP value must be multiplied by the amount that needs to be sold. In this case it would mean 0.0000184*100,000 which would result to 1.84 Euros. In accordance to the derived value that is reached the concurrent dollar rate is what you will get. However, if the PIP changes in the sellers favor by 10 points, the 1.84 Euros will be multiplied by 10 getting an 18.40 Euro profit in concurrence to the dollar.
In the case of a buyer, the PIP is calculated similarly with a few adjustments. For example, if a buyer wishes to buy $50,000 worth of Japanese Yen then according to the exchange rate of 84.30, 0.01 will be divided by 84.30. It will be further multiplied by 50,000, which will result to $5.9 that would concur to its Yen currency. In this case if you purchase the dollar at a loss of a proverbial 10 PIP, you will need to multiply 10*5.9 resulting in a 59 dollar loss, which would concur to the Japanese Yen according to the exchange rate.
While these numbers may seem relatively small, trading in currencies of the exact practice is carried out in millions of dollars as well by large trading companies.
An additional kind of PIP is the fractional PIP, which is a tenth of a PIP. The smaller fraction of the PIP allows you to monitor and track the slightest movements in the market allowing you to make an informed decision.