Securities traders often deal with units of measurement that are uncommon in everyday life. For example, fractions of a dollar smaller than a tenth of a penny show up commonly in trading but are rarely found elsewhere. As with most results-oriented environments, the combination of a high level of usage with rapid-fire activity leads to the adoption of shortcut terms becomes necessary. "Pip" is one such term.
Percentage in Point
The term "pip" is an acronym meaning "percentage in point" and refers to the smallest price unit related to a commodity or currency. For physical currencies like the U.S. dollar or the Euro, this is the one cent piece. On paper, it's the smallest decimal point in the price of a currency or commodity. For example, in the price $1.04, there are four pips. In the number 32.56278, there are eight pips.
Pips are most often used in currency trading, although the term is sometimes used in other trading where investors are focused on very small fluctuations in price -- changes in the 1/1,000 or smaller decimal place. Currency pairs -- equations that describe how much of one currency can be swapped for another -- are most often expressed in terms of four decimal places, with fluctuations in price measured at the 1/10,000th place. Using the term "pip" is a much simpler way to describe differences in price than "ten thousands."
As you can see, the term "pip" is relative to the standard number of decimal places in the system under observation. Within the currencies market itself, the pip refers to the fourth decimal place for most currency pairs, but to the second decimal place when speaking of any pair involving Japanese yen. In addition, the exact value of a pip is relative to what it is describing. If you are trading dollars for euros at 1.0004 to 1.0005, the difference between the currencies is one pip. The exact number of dollars or euros that one pip is worth depends on the size of your trade.
Calculating Pip Value
To calculate the value of your pips, begin by considering the total value of the money lot or shares you are trading. If you are using $10,000 to purchase euros, one pip is worth $1. All changes in pips on the exchange rate will be equivalent to $1 changes in your account. This is also true if you are buying shares or a commodity where the currency does not fluctuate. If, however, you are using 10,000 euros to buy British pounds, you can use one pip = one euro to calculated my gain or loss but this does not take into account the exchange rate of euros back into dollars -- your home currency. To fully understand the market fluctuations, you will need to multiply your pips by the exchange rate for euros to dollars.
- Dictionary of Finance and Investment Terms; John Downes and Jordan Elliot Goodman
- U.S. Commodity Futures Trading Association: CFTC Glossary
- BabyPips.com: Pips and Pipettes
- FinWeb.com: FOREX: What is a PIP?
- DailyFX.com: What is a PIP?
Nola Moore is a writer and editor based in Los Angeles, Calif. She has more than 20 years of experience working in and writing about finance and small business. She has a Bachelor of Science in retail merchandising. Her clients include The Motley Fool, Proctor and Gamble and NYSE Euronext.