Pip-Forex

Financial Dictionary -> Investing -> Pip-Forex

Pip (Forex) stands for percentage in point on the foreign exchange market. A pip is the smallest price increase in foreign exchange, with prices on the Forex market being quoted to the 4th decimal place. For example, the current USD/CAD rate is bid at 1.0268 and offered at 1.0298. Here, we can see that the spread is 30 pips. The only currency that makes an exception is the Japanese Yen (JPY), being quoted to the 2nd decimal place.

Pips are used to calculate profit and loss on the foreign exchange market. Pips are also referred to as points on occasion. A pip amounts to 0.0001 or 1/100 of a cent, which may seem very little at first, but one must consider that most currencies are traded in series or lots of $100 000. For this sum, for example, a pip is equivalent to $10. When the value of a currency increases from 1.2678 to 1.2688, it has moved 10 pips. If a pip is worth $10, it means you have made $100. For the Japanese Yen, a pip amounts to 1 cent as it is only quoted to the second decimal place. One pip equals $1000 if you are trading USD/JPY in $100 000 lots.

The term "lot" is vague to some people. A lot is the smallest traded sum for each transaction with a particular currency. For mini-accounts, you trade in mini lot sizes, equivalent to 10 000 units of the base currency. For regular accounts, one lot is equivalent to 100 000 units.

The spread is the difference in the bid and ask price as well as the difference between the selling and the buying price of two currencies. This is highly significant for investors and traders. The "ask" is the buying price, and the "bid" stands for the selling price. For example, the Euro/US dollar is quoted at a bid of 1.4502 and ask of 1.4505. The spread will be 3 pips. These numbers suggest that your loss is equivalent to 3 pips at the time you enter the trade. Before you can break even, your contract has to increase by an increment of 3 pips. The lower the pip spread, the higher the profit. The pip spread is directly connected to the market value, size, and activity. The bigger and more active a market is, the lower the pip spread will be. Smaller markets are characterized by higher spreads. Brokers offer different spreads depending on the currency in question. Larger regular accounts will usually have lower spreads than smaller ones.

Electronic trading platforms have transformed the foreign exchanges, bringing greater price competition and price transparency. Some of the trading platforms have improved the quote precision for almost all major currency pairs, adding another decimal point. Thus, the rates are now shown in 1/10 pip. With fractional pips, many currency pairs that have been quoted out to four decimal places have added a fifth one. In a similar fashion, those that were traditionally quoted out to two decimal places have a third one added to them.

From the viewpoint of making a profit, it is very important that your broker offers a lower spread, but this is not enough. Take extreme caution when choosing a broker.