When you go to the grocery store, you see some prices change from week to week, but the change is always at least one cent. That’s the smallest possible price change. In the global currency exchange market (called Forex or foreign exchange) a pip is the smallest possible change in the exchange rate (price) of a currency. The pip and pip value are important in the high-risk world of Forex trading because profit or loss from a transaction can turn on a difference of just a few pips.
For most currencies, the pip is 1/100 of 1 percent of the currency unit. For example, if the exchange rate fur the Euro and the U.S. dollar is quoted as EUR/USD =1.2500 it means it costs $1.2500 to buy 1 Euro and the pip is $0.0001. If you turn this around you get USD/EUR = 0.8000 and the pip for the Euro s 0.0001 Euro. One exception is the Japanese yen, which has a small value compared to the U.S. dollar and other currencies. The pip in this case is 1/100 yen.
Currency is traded in lots. One standard lot of U.S. dollars is $100,000. The pip value is how much a change of one pip is worth for one lot. For the U.S. dollar, the pip value is 1/100 of 1 percent of $100,000, or $10. Each currency has its own pip value, depending on its pip and the size of the standard lot of currency.
Forex trading operates on a bid/ask system. A buyer states a bid and a seller an asking price. For wholesalers, the difference (“spread”) is only 1 to 2 pips. Retail dealers mark this up, though usually to no more than 10 pips, and keep the spread as their fee, instead of charging commissions as stockbrokers do.
Forex trades are carried out with very low margin requirements. This is what makes the pip value so important. A trader has to put up as little as $250 to $500 for a $100,000 lot of currency. With a pip value of $10, a change in the exchange rate of just a few pips spells the difference between a large profit and losing the entire amount you put up on margin.
The small changes in currency rates that are important to traders can occur very quickly, so it’s crucial to have an account with a dealer who provides good trading software and real-time quotes. Good brokers allow newcomers to open a practice account and get some experience before they try trading real money. Take the time to learn how market trends, news, monetary policy, and other forces.
Based in Atlanta, Georgia, W D Adkins has been writing professionally since 2008. He writes about business, personal finance and careers. Adkins holds master's degrees in history and sociology from Georgia State University. He became a member of the Society of Professional Journalists in 2009.