The PIP is the smallest measure of gain or loss in forex trading.
Forex, or foreign currency exchange, trading is widely practiced by banks and corporations. It is also popular with individuals who trade for their own profit. Like any specialized pursuit, forex has its own terminology and jargon. The pip is the smallest amount of value change used in currency trading. Changing pips is where the forex trader measures is gains and losses.
Identification
In forex, pip stands for percentage in point, which means one percent of a point or cent. Forex rates are quoted in currency pairs, the value of one currency against the other, and for most pairs the quote is out to four decimal places. A penny or cent is two decimal places so four decimal places is one-percent of a penny. Each digit of the fourth decimal place is called a pip.
Function
Forex rates are quoted in currency pairs. For example the EUR/USD rate is the cost of one euro quoted in U.S. dollars. The second currency in the pair is what the exchange rate is measured and determines the value of a PIP. If the EUR/USD rate is quoted at 1.2237 and moves to 1.2238, the value of the euro increased one pip or 1/100 of a U.S. penny. If you are looking at the EUR/GBP pair, the value of a pip is 1/1000 of a British pound.
Effects
In Forex trading, trades are made in lots of 10,000 or 100,000 units of currency, so a PIP is valued based on the size of the trade lot. Forex traders must know the value of each pip based on the size of their currency trades. Currencies that trade on a dollar cost like the EUR/USD and GBP/USD have a pip value of $1.00 for a 10,000 unit trade and $10.00 for a 100,000 currency unit trade.
Considerations
For currency pairs where the dollar is quoted first, the pip value can be calculated by using the inverse of the exchange rate. For example the USD/CHF (Swiss franc) is quoted at 1.1508. The value of a pip on a 10,000 unit trade is one divided by the 1.1508 or $0.87. For cross currency pairs, such as EUR/GBP the calculation includes converting pounds to dollars then calculating the pip value. The trading software for any forex broker will provide the pip value based on currency pair and size of a trading unit.
Exception
The one exception to the pip rule is trading in the Japanese yen--JPY. A single yen has a very small value compared to other major currencies, so the pip on the USD/JPY, EUR/JPY or other yen currency pair is quoted to three decimal places. For example, the USD/JPY rate may be 89.575 with the PIP at the third decimal. In this example, a 10,000 unit trade will have a pip value of $1.11.
