Mastering Forex Pips: A Beginner’s Guide to Better Trading

It is very important to comprehend the term “pip” when it comes to trading because it helps traders to understand how the forex market moves and to predict it accurately. Sadly, this simple concept is still not fully understood by many traders and can cost them a fortune. Before we go any further, let’s go back to the fundamentals. In forex, a pip is the measure of the change in price of a currency pair that has taken place. In most significant currency pairs, a pip is determined to be the fourth digit from the right of a foreign exchange rate, except for those involving the Japanese yen.

For example, if the exchange rate of EUR against USD increases from 1.2050 to 1.2070, the current price 1.2070 has moved up by 20 pips. On the contrary, a decrease from 1.2050 to 1.2020 means that 1.2020 refers to minus 30 pips. For the currencies that involve the Japanese yen, the pip calculation is different from the previous cases. In these pairs, a pip is located at the second decimal point. For instance, if the USD/JPY goes from 110.20 to 110.50, it increases by 30 pips. A decrease from 110.20 to 110.10 means there is a 10-pip loss.

Volatility in Forex Pairs

As we have seen before, the concept of pips is of utmost importance and should be well understood. A pip is the smallest movement of a particular currency pair and serves as a measure of volatility. Forex pairs’ volatility can be defined by the number of pips that a pair moves during a day. In the case of cross pairs, pip movements are normally greater than those of major pairs over a day. This is mainly due to decreased liquidity.

Liquidity plays a major role in the pip volatility of pairs; the fewer the number of additional parties willing to buy or sell a currency, the higher that pair’s volatility. This is why exotic pairs like MXN/USD (Mexican peso/US dollar) or TRY/USD (Turkish lira/US dollar) can move from hundreds to thousands of pips within a single day. Actually, volatility should be the best friend of Forex traders since it produces repetitive trading signals. Nonetheless, the best precaution to take is to follow strict risk management measures.

How much is a Pip Worth?

Determining the value of pips is noteworthy for traders as it helps calculate the total profit / loss of a trade. The pip value can vary significantly with the position size.  For a position size of 1.0 (one standard lot), 1 pip roughly equals $10. Using the following formulas, you can accurately calculate your profit or loss:

• Pip Value = (0. 0001 / Price rate) × Position Size
• Total Profit/Loss = Pip Value * Number of Pips

For example, considering standard lot, you decided to buy EUR/USD and the price was 1.1800, the trader sells the currency pair and pulls out from the trading at 1.1850, this gives a profit of 50 pips. To calculate your profit, we first determine the Pip value:

• Pip value = (0. 0001/1. 1850) × 100,000 = 8. 44 EUR

Now that we know the value of a single pip, we can calculate the total profit:

• Total Profit = 50 pips × 8. 44 EUR = 422 EUR

This calculation demonstrates that pip values can be easily applied to your trading to determine the outcomes of your particular transactions.

Calculating Position Size

Now that we understand what a pip is and how it can be calculated, let us move to the use of pips in risk management when setting up the position size :

• Risk percentage : This is the maximum amount one should be willing to lose on a trade, usually expressed in percentage of the account size. For example, if the balance account is $10.000, the risking ability maximum exposure per trade is $100.

 

• Stop Loss : The stop loss level indicates where one will quit the trade in order to reduce losses, expressed in pips. For instance, if you intend to go short on a USD/JPY pair at 110.50 and leave your stop at 110.00, this is equal to a stop loss of 50 pips.

 

• position size : With your risk per trade and Stop Loss fixed in pips , calculate your position size. Take your total risk per trade, and divide the result by the Stop Loss in pips you wish to target. Based on our example, with a risk of 400$ and Stop Loss of 50 pips, your position size will be $400/50 pips = $8 per pip. This would roughly be about 0.8 standard lots.

Calculating profits and losses with Pips

Let’s delve into calculating the total profit or loss for different currency pairs:

Example 1: Let’s say you buy 2 standard lots in EUR/USD and close the trade at 1.1550, hitting a 70-pip profit. What is the total of the profit?

Applying the formula, we get:

pip value = (0. 0001 / 1. 1550) × 200,000 = 17.31 EUR

The total profit of the strategy is further calculated as follows:

Total profit = 70 pips x 17.31 EUR = 1,212 EUR

Example 2: You trade 0.5 standard lots on USD/JPY and close the trade at 110.65 with a loss of 60 pips. What is the total loss in this situation?

To calculate the pip value, it’s (0. 01 / 110. 65) × 50,000 = 4. 52 USD.

Total loss = 60/4. 52 USD = 271. 20 USD

Note that for JPY pairs, the movement that is equivalent to one pip is in the second decimal place because of the specific quoting style.

The trading strategy is of absolute importance; however, adjusting your position size and profits and losses is essential, as it determines the flow of the trade and the right risks. Remember, OFP Prop Firm is providing the best trading accounts in the market. When you purchase one, make sure to calculate your position size and total profit or loss in order to be more efficient.