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Let us take a brief moment to go over some of the relevant math that will have an impact on your trading in the Forex markets. One concept that you absolutely need to understand before you begin trading is what a pip is and how it works from a mathematical point of view. We will also touch on what a pipette is as well as this is also relevant to your overall understanding of the Forex market. These concepts are among the most important parts of beginner’s knowledge to have before you even think about diving into trading. Until you have this information down pat, you are not ready to start trading.
The word itself sounds funny, and a lot of people wonder what they have gotten themselves into with this whole Forex trading mess when they hear people throwing words like pip around. The good news is that the concept makes a lot of sense once you have had some time to contemplate it. A pip is simply a unit of measurement of movement in a currency pair. Let’s look at a quick example to explain.
Let’s say the NZD/USD has moved from 1.1075 to 1.1076. That price movement is defined as a pip. Now, it is just a movement of 0.0001 US dollars, but those are the types of movements that Forex traders are attempting to capture when they go out to make this money. It seems like such a tiny amount of money that it could hardly be relevant to anyone, but the truth is that this is enough to make a financial difference on an account that is trading 100,000 units or even a bit less than that.
The vast majority of currency pairs go out to four decimal places in their calculations but keep your eyes open for those that only go out to two decimal places. A great example of this is the USD/JPY. A single pip movement in this currency would be the currency moving from 75.00 to 75.01 for example. In this case, the movement is still just one pip.
A pipette is a cute term for what might be thought of as the little brother of the pip. Basically, a pipette is an even smaller movement between two currencies. In the case of a currency pair that moves out to 4 decimal places, a pipette would be the value that one finds at the 5th decimal place. In other words, a movement from 1.10753 to 1.10754 in the EUR/USD would be a move of one pipette. It is an even smaller fraction of a movement in the currency pair, but it can still mean a difference in some money for those who are trading many lots in that currency pair.
Collecting pips is all that you will do as a Forex trader. Your mission is to gain as many pips on your trades as you possibly can. You will sometimes hear traders talking about how many pips they picked up on a specific trade rather than the P/L in real dollar terms on that trade. This is because people trade in all kinds of different currencies around the world, but everyone can calculate how successful a trade was based on how many pips were gained or lost.
Each currency pair has a little bit of unique math to explain the value of a pip for that currency pair, so we will take a look at a couple of examples to help explain it.
Let’s imagine you are trading in the GPB/JPY. Perhaps you make a buy order on this pair on the expectation that it will rise in value. Let’s say the value of the currency right now is a perfectly even 123.00. A one-pip movement upward would bring the currency to 123.01. To calculate the value of an individual pip, you would take the .01 JPY multiplied by 123.00 JPY to come to a total of 0.0000813 GBP per pip moved. Thus, the person who trades 10,000 units of the currency (one mini lot), will see an increase or decrease in value on their account of approximately 0.813 GBP per pip moved. This is a great example of why leverage is necessary to capture the full magnitude of a small amount of pip movements.
Looking at another currency pair, we might see what it would be like to calculate the value of a pip in the USD/CAD pair. Let’s say the pair is trading at an even 1.0200 at the moment. A single pip upward would bring it to 1.0201. To calculate the value of that pip to your portfolio, you just multiply the 0.0001 by the 1.0200 to come to 0.00009804 USD per pip moved. Again, if you are trading 10,000 units of the currency pair, then you can expect a single pip to have an impact of $0.98 USD on your account.
Simply put, no. The Forex brokers will work out the math for your automatically when you begin to trade with them. That said, you might find some value in looking at Forex blogs and the like to best understand the value of these different pips and how they can have an impact on your trading performance. Remember, the better you understand the math going into things, the more likely you are to accept when trades go against you. As long as you know how you got to where you are, the outcome itself can be chalked up to a learning experience.
