Pips: what are they?
Even if you are a newcomer in it you have certainly understood that in the FX market all revolves around 'pips': when someone gains, he gains pips, when he loses, he loses pips. But what are they, actually?
Pip is an acronym and stands for Percentage In Point and pips are also called just points.
They represent the smallest unit indicating prices' fluctuations in forex trading.
Currencies' prices are usually quoted to the fourth decimal point with the exception of the Japanese Yen (JPY), that is quoted only to the second decimal point.
In other words we can say that pips are the smallest unit of a currency's price and they are the last decimal points in a pair's quote or in an exchange rate.
Now we know what a pip represents, but what is its value?
You may think that it is not simple to determine it with all the currencies and their possible combinations the FX market offers. On the contrary, it is pretty easy to calculate. Simply divide one pip (0.0001 except for JPY, among the major currencies) by the exchange rate and you will know what a pip is worth.
Let's see it in an example. Let's imagine that we have EUR/USD with an exchange rate of 0.8942. We just have to divide a pip (0.0001) by this rate (0.8942): 0.0001/0.8942 = 0.00011183
Now we need to convert this value into "actual" money. To that end we have to multiply it by the notional amount we are trading, let's say 1.000 USD: 0.00011183 x 1.000 = 0.11183 $
A pip, in the transaction we have imagined, has got a value of 0.11 $
So, if you have a profit (or loss) of 10 pips it means you have gained (or lost) 1.11 $.
It doesn't seem that much, does it?
In order to maximize your profit chances you may take advantage of "leverage trades" or "trades on margin"(they indicate almost the same thing, only on a different point of view). These techniques allow traders to use credit and play with far larger amounts.
For example if you are allowed to trade with a leverage ratio of 100:1 it means that you can trade 100 currency units by only depositing 1.
So, in our first example, by putting up 1.000 $ we can actually trade up to 100.000 $! Let's see again what a pip is worth now: 0.00011183 x 100.000 = 11.18 $
Our profit of 10 pips would be worth 111.83 $ now! It sounds better, doesn't it?
But keep in mind that you maximize losses as well: so, be careful!