In Forex trading, you will hear and see a lot of frequent terminology. The most common term that is used with Forex traders is “pips.” To understand Forex trading, you must understand what a pip is so that you know what other traders are referring to.
A trader will have increased or decreased pips as part of their trading activities. When traders refer to pips, they are referring to their percentage in points. A pip is the smallest unit of price for any given currency. The pip is the last decimal point of an exchange rate.
For example, if you bought USD/CHF at 1.2375 at a 0.0001 exchange rate and then sold it for 1.2455, you profited by 8 pips. It might seem like a small profit, but if you consider the fact that you will generally trade in high unit amounts, 8 pips works out to quite a bit of money.
Pips are extremely important. A pip is how profits and losses are measured. Without pips, traders would not know whether a trade is making them money or costing them to lose money.
Calculating the value of a pip is fairly simple. For US based currency pairs, the pip is divided by the exchange rate. For US quoted currency pairs, the pip is always the value of one pip. Although your end numbers may seem extremely small, you have to keep in mind that Forex allows you to leverage that small number to make large profit amounts.
Ultimately, brokers determine the amount of leverage that you can trade with. For example, your broker gives you a leverage ratio of 100 to 1. This means that you can buy $300,000 in currency only using $3,000 as leverage.
If you didn’t have the ability to use leverage, your profits would be much lower. For example, if you were $1000 in currency, your profit would only be $0.08 per pip. With the ability to use leverage your profits go up to $8.01 per pip.
Pips are vital to calculating in Forex trading. Without pips, there would be no point in trading at all. The main reason people get involved in trading to begin with is to earn high profits. If traders don’t know how much money they are making, there would be no traders at all – in any market.
