1.21 Pips, Pipettes and Lots in Forex

 

What is a Pip?

 
A ‘pip’ stands for ‘Price Interest Point’ or "Percentage in Point" and is used as a unit of measure of the change in value of a currency pair – a pip is the smallest allowable fluctuation in its price. 
 
Most of the currencies, unlike Japanese yen, have 2 decimal points e.g. 1 dollar = 100 cents. But what about the currency pairs when once currency is quoted in terms of other? 
 
As you have seen in an earlier lesson "Currency Quotes and Decimal Places", most of the currency pairs are quoted against others in four decimal places. There are a few which quote in 3 decimals and some which are quoted in 2 decimal points. If a currency pair is quoted in 2 decimal points (e.g. USD/JPY =113.24) then an addition of 1 on the second decimal point means an addition of 1 pip. If there are 4 decimal points (e.g. EUR/USD=1.1423) then change of 1 on the 4th decimal point means change by 1 pip.
 
Among major currencies only Japanese yen pairs are quoted in 2 decimal points and rest all in 4 decimal digits.
 
Thus if the EUR/USD was quoted at 1.1423 and then moved up to 1.1424, it would have moved 1 pip. Similarly, if the USD/JPY was quoted at 111.09 and then moved down to 111.07, it would have moved 2 pips.
 
Representation of a Pip.
 

Pipettes are just Fractional Pips

 
A number of brokers quote even finer rates these days – their quotes incorporate an additional decimal place. Such a broker would quote EUR/USD as 1.30654 or USD/JPY as 78.091. The additional decimal place is actually a "fractional pip" – also known as a "pipette".
 
Representation of Pips and Pipettes

Calculating the value of a pip

 
Here we are assuming that your account currency is U.S. dollar. Even if it is not, please read through and we will get back to your problem soon enough.
 
The concept of the value of a pip is best understood with an example.  Let’s say that EUR/USD pair is quoted at 1.1423.  Here, 1 Euro equals 1.1423 U.S. Dollars.  A standard lot of 100,000 Euros is worth 114,230 U.S. dollars and a fluctuation of 0.0001 (1 pip) is worth $10 (100,000 x 0.0001). (‘Lots’ are explained later in this chapter). Therefore, every time the price of the euro relative to the dollar moves by one pip, the value of each lot changes by 10 dollars.  For currencies that are quoted in terms of dollars (that is, when the USD is the counter currency, i.e. quoted second), the pip value is fixed (10 dollars if the currency is quoted to the fourth decimal place as the EUR/USD is).  This is known as a "static pip value" because the pip value is constant as against the U.S. dollar.
 
Here’s the math, shown step by step for EUR/USD quoting 1.1423:
 
Pip value = .0001 divided by the rate.
Or, .0001/1.1423 = EUR 0.00008754
 
Since we want the value in U.S. dollars we convert this by the exchange rate i.e. EUR x the rate
Or, 0.000087542 x 1.3065 = $ 0.00099999
 
Multiplying this with our lot size of EUR 100,000 we get $ 9.9999, which is rounded to $10. If your account currency was euro then in terms of euro the value of 1 pip would have been 10/1.1423 = EUR 8.7527.
 
When the USD is the base currency (i.e. quoted first in the pair), the value of a pip will change as the value of the other currency changes.  For example, assume you receive a bid quote for the USD/JPY pair of 78.09.  Here, 1 U.S. Dollar equals 78.09 Japanese Yen.  Thus, 1 lot of $100,000 U.S. dollars is worth 7,809,000 Japanese Yen and one pip is worth 1000 Yen (100,000 divided by 0.01).  When divided by the exchange rate, a one pip change will equal 12.8057 U.S. dollars.  This pip value will change as the exchange rate changes which is why it is called a "variable pip value” - the pip value not being constant relative to the dollar.  
 
Here’s the math, shown step by step for USD/JPY quoting 78.09:
 
Pip value = .01 divided by the rate.
Or, .01/78.09 = $ 0.00012805736
 
Multiplying this with our lot size of $ 100,000 we get $ 12.805736, which is rounded to $12.81.
 
Depending on the currency pair you are trading with and your account currency, the calculation of pip value may be little more complicated. You don’t have to do that entire math manually. You can just use the tool called Pip Value Calculator
 

Forex Lots

 
A lot is the standard unit size of a transaction. Typically, one standard lot is equal to 100,000 units of the base currency, 10,000 units if it's a mini, or 1,000 units if it's a micro as you will also see in the next lesson.  Some dealers offer the facility of variable lot sizes so that you may trade in any unit size, down to as little as 1 unit. You may also learn more about Forex lots at "Forex Account Types".

 

 
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