Forex Terminology - Understanding Pips

What is a pip?

A pip is the smallest unit of price for currency pairs, given that the price is quoted in four decimal points (with an exception for currency pairs involving JPY, where the price would be in a standard two decimal points). Because some forex brokers quote prices to the fifth decimal point, the minimum price unit in this case would be one-tenth of a pip which is called a "pipette".

What is the value of a pip?

The value of a pip varies depending on the instrument. But it is safe to say that any currency pair involving USD would have a pip value of one-hundredth of a cent ($ 0.0001) with the exception of USDJPY. With USDJPY the pip value is one cent ($ 0.01) because the price is quoted in two decimal points. Although its straightforward to determine the pip value for instruments when the account denominator is USD, there are further calculations required if the account is in any denominator other than USD.

Pip-value in relation to actual trades

The value of one trading lot is determined according to the type of account traded in. Forex is traded in lots because it is not feasible to let gazillions of traders place orders only for few units each, and the minimum trading quantity in forex trade is a micro lot. Commonly there are three types of accounts - micro, mini and standard. Micro lots are traded in micro accounts; mini accounts trade mini lots and so forth.

A micro lot is worth $1000, a mini lot $10000 and a standard lot $100,000. Because an average part-time forex trader would be reluctant to risk even $1000 for a single trade, forex brokers provide margin accounts that uses leverage. If the leverage of an account is 1:100 then the margin the broker needs to hold in order to open one micro lot is $1000/100 = $10. In this case the value of a pip will be $0.10 because one micro lot is worth $1000 (0.0001 x $1000). Similarly, value of a pip in a mini account would be $1 and in a standard account $10.

The importance

Money management without a doubt is the single most reason that affects the success as well as the failures of forex traders. So it is important to understand the actual face of margins and leverage. Without a basic knowledge of a pip and how the value of a pip is calculated, a novice forex trader has the least bit of chance to survive in forex markets.