Trading is an activity that requires effort, hard work, and – most importantly – knowledge. The purpose of Traders Trust’s educational articles is to provide traders with as much material as possible to increase their knowledge base so that they can get the most out of their trading.
Today we are going to study a basic concept in trading, and in the world of finance: The Pip (Percentage In Point or Price Interest Point).
As its name suggests, the Pip is part of a mark’s price, it’s a decimal, a number, which determines the price of an asset. If you look at the prices of the main forex pairs, they are made up of 4 or 5 numbers (see the image below).
The first number before the comma is a whole number. The numbers that follow are the decimals.
If we take, for example, the EUR/USD pair (euro – US dollar) we see that, at the time the image was taken, the dollar was worth 1.20429. If we count the decimals that follow, we can see that there are 5. The fourth decimal place is called Pip and it represents one-hundredth of one percent. In our example it would be the number 2. We could say that, generally, the pip is the smallest part by which the price of an asset can change.
To define the concept, we can say that the Pip is the fourth decimal place of a forex pair that represents one-hundredth of one percent (0.0001).
How is a Pip calculated?
The value of the fourth decimal place – or Pip – is calculated by dividing 1/10,000 or 0.0001. So, when opening a trade, you only have to multiply your investment by 0.0001.
0.0001*20.000 = 2
Therefore, following our example, every time the EUR/USD moves in any direction you will gain or lose 2 dollars, depending on whether we are buying or selling.
What is a Pip for?
As we mentioned earlier, a Pip can be expressed as the smallest change that a forex currency can undergo. Therefore, this decimal will guide you when trading any currency.
When you watch the economic news, you can see how the euro appreciates more or less against the US dollar simply by varying decimals. It does not have large substantial changes. For example, one day it can be at 1.2023 and the next day at 1.2028
These small changes in trading operations can translate to great gains or losses, which is one of the reasons why trading has become so popular in the last few years. Can you imagine how much you could potentially make, trading short, if the EUR/USD went from 1.20 to 1.16 in a couple of months? (This actually happened in October 2020). That is why the Pip is important.
Trading Note: In most forex currency pairs the fourth decimal place is considered to be the Pip, except for the Japanese Yen, whose price is only expressed in two decimal places (in this case to calculate the Pips of the Japanese Yen you would have divide it by 1/100 because it only has two decimal places).
In any case, knowing what a Pip is based on and what it is used for will help you make better trading decisions.
What affects Pip to change?
As we have already mentioned before, the daily variations of the Pips of forex pairs are minimal, but at the same time, they translate into losses or gains in the millions for a country. What is it that makes one currency appreciate more than another? Well, the answer directly depends on the social, political, and economic situation of the country.
For example, with the COVID19 pandemic, many countries have been affected by national confinements and this has caused many businesses to close. Airlines and the hotel industry were especially hit. Consequently, these companies have been forced to drastically restructure their workforces, which had a direct impact on society. As a result, countries that make a living from tourism, such as Spain and Greece, have seen their source of income get affected. These types of problems as well as political decisions or social unrest are some of the direct causes of changes in currency appreciation.
Trading Note: The fourth decimal place of a forex currency pair is called Pip and the fifth Pippeta. At Traders Trust we offer the fifth decimal place to give traders a more accurate and realistic price.