I’m a Pip, You’re a Pip, and everybody is a Pip… so what is a Pip?

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“Percentage-In-Point” is known as a PIP and is used to define a currency rate to a very small amount well below whole numbers. Different currencies are traded around the world and using this system helps equalize each currency against the other for much more accurate measurement. Ok, now you have an explanation that doesn’t really tell you much, so let’s look at a PIP.

In trading the U.S. Dollar, the pip is the smallest amount by which it may be traded against another currency, in this case $.0001! Other currencies using other types of units but using this system of pips helps to bring about nearly exact exchange rates by considering both currencies to a very small unit of measurement. Currency on the whole only fluctuates a very little amount, but when you multiple that amount by the volume traded, it is a great deal of profit and loss. When the USD moves just one PIP and you are trading 100,000usd, you could have profited or lost 10.00dollars, now just think that if the currency moved 5 PIP, that is 50.00 for doing nothing. There is over 2 trillion dollars traded daily on the Forex Exchange. That is 2,000,000,000.00 now if we multiply that by 1 PIP, we have a whole lot of money going up and down.

When trading Forex Currency, the trader is leveraging their account, in other words, they may be buying 100,000USD but they are only using 100.00 of their money. (This is a hypothetical example; leveraging and margins are governed by the exchanges and set by your broker). The smallest amount that can be traded is a contract for 100,000usd, so every little PIP counts.

Traders look to make a profit by betting that a currency’s value will either appreciate or depreciate against another currency. Trading down to such a small unit or pips helps protect investors from huge losses by allowing specific places for trades to occur. Instead of waiting for a whole number such as 1, or even 5 dollars, for instance, when the market reaches a specific small unit, trades may occur. If a trader can trade the dollar down to 1.0001, it is easy to see that large volumes of dollars trading at 1.0001 instead of at the next whole number, $2.0 can mean vast amounts of money are at stake.

Trading one whole unit of one currency may result in a lot of whole units of another currency. Since one US dollar may represent hundreds, thousands, or even more of another currency, using pip increments helps match the currencies together and maximize the attempt to equal one to the other exactly.

Once we identify the two currencies this is known as a “pair” and use pips to match up the values of each to such an exact degree, it becomes a small step to use the system itself to identify and quantify a trade between currencies! This is how you make money trading the Forex Market.

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About:FX Empire Analyst - Barry Norman

Barry produces a private Daily Market Review newsletter that is distributed around the globe to over 25,000 subscribers and recently published a book on Options Trading that is available from amazon.com

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