Understanding The Concept of PIPS In Forex Trading

Forex trading is a battle of risk and reward. To play it safe, you must understand the role that pip values play in the forex market. By definition, a pip value is the smallest unit of measurement for price changes in currency pairs.

In simpler words, a pip represents the smallest change in the value of the currency pair. Let’s understand the concept of pips in detail to better understand the topic.

Importance of PIPS in Forex Trading

PIP is a fundamental concept in forex trading that allows traders to measure the risk of holding a position. For instance, let’s say a pair moves by a pip in the direction you’ve opened a trade in. This means you have an unrealised profit of 1 pip.

If you close your position at this point, you will realise a profit of 1 pip, but if the pair moves in the opposite direction, you are at risk of losing 1 pip or more, depending upon when you close the trade.

To easily determine how much profit or loss you have made in a trade, you can use a profit calculator, which shows you the numbers in your own currency.

Coming back to pips, then if you don’t know the pip value, then it’ll be hard to calculate the margin requirements accurately, and as a result, managing risk would be a problem.

The importance of Pips is about more than just risk management. It also helps you make informed decisions about position sizing, especially in leveraged trades where the pip value of positions gets multiplied by the amount of leverage used, increasing the risk on a specific trade.

However, with the help of pip value calculations and using the right money management techniques, you can determine the ideal position size for any trade and make sure that it is within the limits of your account size and risk tolerance.

Without the pip value knowledge, you may take too much or too little risk on a trade. While taking too much risk can wipe out your account, taking too little risk may limit your returns.

How To Calculate Pips?

Calculating pip value is crucial, but doing it with precision and accuracy is important. Each pip must be multiplied by the specific lot or contract size to find its monetary value. For standard lots, this would be 100,000 units of the base currency, while mini lots would be 10,000 units.

As pip value calculation allows traders to determine the monetary value of their trades, they can use this information to set take-profit targets and stop-loss at appropriate levels.

Instead of merely analysing pip movements, traders can also determine how their trading account’s equity will fluctuate with respect to the movements in the market, ultimately helping them to find the profit or loss on a position.

One important thing to keep in mind while calculating a pip value is that the value of one pip varies for different currency pairs. This is because the value of one pip is always displayed in the currency of the quote or variable currency, which varies when trading different currency pairs.

For example, when trading the EUR/USD pair, the value of one pip will be expressed in USD, whereas when trading the GBP/JPY pair, the value of one pip will be in JPY.

Mostly while calculating pips, quoted prices are placed up to four decimal points. In such conventional exchanges, one pip would be equal to one unit of the quote’s fourth decimal place.

However, in real-time pip calculations, things are rarely that simple, and to ensure accuracy and save time, all traders use a standard pip calculator.

When it comes to currency pairs that include the Yen, a different convention is followed. The Yen is only quoted up to two decimal points. This also implies that the pip value will always be significantly higher or lower for every currency pair with the Yen in it, adding further complexity to the pip value calculation.

What is the Difference Between Pip, Pipette and Tick?

In the forex market, several price measurement tools are used to determine the value of different currency pairs. One such term is the pip, which, as we read above, represents the smallest unit of price movement.

It stands for ‘point in percentage’, ‘percentage in point’, or ‘price interest point’ and is represented to the right of the decimal. PIP is used to express the change in price between two currencies.

The smallest fluctuation in the value of most currency pairs that are quoted up to four decimal places can be measured with the help of the last decimal point, for example, if the trade entry price of EUR/USD is at 1.3645 and it goes up to 1.3646, the price has increased by 1 pip.

Some traders also use the term ‘pipette’, which represents the smallest unit used to measure and represent the change in value between currency pairs.

While there is no difference in definition between a pip and a pipette, the values are calculated differently. Pip values are only calculated up to the 2nd and 4th decimal places, while pipette values are calculated up to the 3rd and 5th decimal places. Pipettes are essentially the decimal odds, while the pips are decimal evens.

Now coming to ticks, it is made up of pipettes. Ticks are fractional price movements on a currency pair. It represents the difference between the current and last-quoted prices or the amount the market has moved in a given time.

However, the value of a tick is not a fixed number and fluctuates in real-time depending on market conditions.

How Many Pips Should Be Targeted Per Day?

Many forex traders enter the market with the aim of hitting a specific number of pips daily. It’s like they want to collect as many pips as a kid collecting candies on Halloween. But this approach can be dangerous and unproductive.

Firstly, no trade is guaranteed to give positive returns. So trying to achieve a daily pip goal is a recipe for disaster. The market is volatile, and setting such unrealistic expectations is setting yourself up for failure.

Moreover, this approach encourages traders to trade more when their strategy is ineffective and to trade less during periods when their strategy could be more effective. It’s like a football coach instructing the team to score three goals in every match. It’s unrealistic and counterproductive.

What if a trader hits their daily pip goal in the morning and stops trading? They may have missed out on potential trades that could have occurred during ideal market conditions.

Every strategy has its ideal market conditions, so traders must be flexible and adaptable and not limit themselves to a specific number of pips per day.

The forex market is unpredictable, and the ideal market conditions can change frequently without warning. Therefore, traders should work on building a well-defined strategy and consistently sticking to it.

It is also a good idea to practise their strategy on a demo account. They should also use all the necessary trading tools to ensure a smooth trading process. This way, they can perfect their skills, test their strategy, and learn to adapt to changing market conditions.

Conclusion

The intricacies of calculating percentage in point, or pips, in forex trading can be complex and perplexing, especially for those who are just starting out. While there are some established conventions that most standardised currencies follow, the calculation of pips can vary depending on the currency pair being traded.

Therefore, traders need to learn the basics of pip value calculation even when they are relying on a calculator. This will help them understand how things work in the forex market.

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