What is a pip in the forex market?
A pip means “percentage in point.” For some, it is a “price interest point.” A pip stands for the minimal currency pair movement in the market. It is common for currency pairs, especially the US dollar-related currency pairs like the GBP/ USD or the EUR/ USD, to be equal to 1/100 of a percentage point. For example, it is a currency pair’s 1/100th of 1%. We can also refer to pip as one basis point, fourth place succeeding the decimal points in price quotes. This size is the standard so that investors can avoid huge losses.
Tell me more about the pips.
As we have mentioned, a pip’s place is on the currency pair’s fourth decimal place. In forex trading, it is considered the most basic unit of measurement. A number has lesser significance as it goes further away from the decimal point. In simple arithmetic, a fourth decimal place has a lesser value than the third decimal place. If a trader would look at a pip’s value individually, it almost amounts to nothing because it is so minimal, and you cannot even buy anything with it in real life. However, one should not underestimate a pip’s importance because it may turn a trader’s fortune around. It can create a significant profit or loss from albeit its small unit of measurement.
Furthermore, it is not all the same for currency pairs. For example, Japanese-related currency pairs are one percentage point and second after the decimal point in price quotes, unlike other currency pairs that are usually in the fourth place after the price quote’s decimal point.
A sample scenario with a pip
Let us take the GBP/ USD currency pair as an example. Let us assume that this currency pair’s direct quote is 0.8888. It means that you can buy 0.8888 USD for every GBP. If there is a pip increase in the GBP, even if it is just one pip, GBP will become a more robust currency because you can buy more USD using that £1.
Again, looking at one pip as an individual might mean almost nothing in a person’s daily life and finances. But upon thinking about it, a billion will never be a billion without 0.0001. Once accumulated, the amount can be significant. If a trader purchases 5,000 USD using the GBP, he must pay a total of £5,625.56. The equation will go something like this: (1/0.8888)*5,000)= £5,625.56.
If in case this currency pair has changed in the exchange rate, say a one pip increase or 0.0001, then the equation would be something like: (1/0.8889)*5,000)= £5624.93. One pip indeed has a minimal value, but we can see a noticeable difference in the price in this case. Here, it is just for a trade of $5,000. Imagine what it can do for thousands or millions more.
The bottom line for pips
This effect is not only applicable in gains to make a trader go home with a profit. A pip can also cause a massive loss. Thus, a trader must know well how the market works from the inside to the outside. Some things that you may find insignificant and minimal may be something that can cause significant distress or success.