A pip is a general term for the minimum unit of price change. The term is mostly popular among Forex currency pairs traders because it’s inconvenient to calculate miniscule fluctuations of two currencies in dollars or euros. It's easier to say that the price grew by 540 pips than 0.0054 euros, isn't it?
An important detail about the FX pip is that it depends on the accuracy of the price measurement. Some brokers offer 4-digit quotes – here the accuracy of price measurement is limited to ten thousandths. In this case, the pip change of the fifth last decimal point in the EURUSD price – for example, from 1.00000 to 1.00004 - will go unnoticed. A one-pip change for a 4-digit Forex broker will equal a 10 pip change for a 5-digit quote.
Calculating Pip value
To do this, we need to know:
The cost of 1 lot of the traded instrument. In currency trading, it is usually 100,000 units of the base currency (which is the first in the quote). The second currency in the pair is known as the counter currency. For example, the cost of 1 lot of the EURUSD = 100,000 euros. The cost of 1 lot of the GBPJPY = 100,000 pounds, etc.
- The cost of the instrument. Let's take EURUSD again. At an exchange rate of 1.20000, buying 1 lot (100,000 euros) will cost 100,000 x 1.20 = 120,000 dollars.
If we sell 1 lot at a price 1 pip value higher, i.e. by 1.20001, as a result of such a trading operation we get 100,000 x 1.20001 = 120,001 US dollars. Therefore, we can earn 1 dollar on a move of one pip, which is the cost of a single pip on this instrument.
Other instruments are calculated using the same method.
Let’s take the USDJPY as an example of unconventional 3 decimal digits in the exchange rate calculation.
Cost of 1 lot - USD 100,000
We’ll assume the exchange rate of the instrument is 105.300
In the example with the dollar and the yen, the minimum price fluctuation would be 0.001
When buying 1 lot of the USD/JPY, you need 100,000 * 105,300 = 10,530,000 Japanese yen.
If the exchange rate rises by a single pip to 105.301, then 1 lot (100,000 US dollars as a base currency) can be sold at 10,530,100 yen (counter currency).
Therefore, the trade value of one pip here will be 10,530,100 - 10,530,000 = 100 yen.