Some topics in forex are considered pivotal and complex, and they are closely connected to every detail in trading.
What is a pip?
How is a pip calculated?
Does the value of a pip differ from one pair to another or from a currency pair to a commodity?
Does knowing how to calculate the pip affect lot size and the risk management plan?
All of this is what we will learn in this article, dear reader.
Prices always move in what is called a pip, whether upward or downward. You may hear that the average daily movement of the GBP/JPY pair is 250 pips, while EUR/USD is 60 pips, which makes you wonder: what is a pip?
Definition of a pip:
It is the unit of movement that measures exchange rate price movements for each currency pair individually. A pip consists of 10 parts. If you decide to enter a buy trade on EUR/USD for example, and choose a 0.01 lot, then the value of one pip in profit or loss here is 10 cents. How did that happen?
And how is the pip calculated?
In dollar pairs and cross pairs, the pip is calculated from the fourth digit after the decimal point, while in yen pairs it is from the second decimal place.
If the change in EUR/USD for example is from 1.87450 to 1.87440,
the change here is only one pip.
To calculate the monetary value of a pip:
Pip value = pip = 10 parts × contract size, also called lot (0.01) = pip value in dollars.
The pip value differs from one pair to another and from one commodity to another. Gold is not like Bitcoin, and oil is not like EUR/USD. Its value also differs from one broker to another. In this case, you can ask the broker about these details, as they will affect your trading. Any change in pip value will change its dollar value when calculating.
You should also know that brokerage companies take their commission in the form of pips. Meaning, when opening a trade, for example, one and a half pips are taken as commission. This is related to the spread, which we will explain in a separate article. But know that the commission is also in pips. So if one pip equals 1 dollar, then one and a half dollars will be taken from you as commission on EUR/USD for example.
As for capital management, imagine that your account has 10,000 dollars and you want to risk only 1% of the amount on each trade.
The first trade has a stop loss at 50 pips, and the second has a stop loss at 80 pips. Do you think you will use the same lot size or contract size in both trades?
Of course not. The contract size will change according to the number of pips so that the risk percentage remains 1%.
You have now realized the importance of knowing the pip in all its details, and we will explain in detail, in the risk management section, how to calculate the risk-to-reward ratio.
