Forex Pips: What About Computing Profits on Forex Margin Accounts? What Are Pips?
What’s a Pip, you ask? A Pip is the MINIMUM increment a forex cross rate will trade in, and is easy to figure out based on the previaling quote for that cross rate. For example, USDJPY would be quoted something like 82.35 at any given time. The ’5′ or hundredth of a Yen digit is the smallest increment that USDJPY is priced in. You can buy Yen at 82.34 per dollar, or 82.35 (or 82.36, etc), but you CAN NOT buy Yen at 82.355 per dollar, because Yen are NEVER quoted to a third decimal place.
Most other currencies are quoted to four decimal places. GBPUSD today for example might be quoted at 1.6544, but it WON’T be quoted at 1.65447, because currency cross quotes are only carried out four decimal places. If a question in your mind ever arises, simply find a quote either on your broker screen or any newspaper. Whatever is the last decimal place of the quote is the Forex Pips amount.
Why Do Pips Matter In Forex? Why Do Forex Traders Use Pips?
Again this is to make communication easier. It’s simply a pain in the ass to say the bid/ask GPBUSD is 1.6455 / 1.6457, or that I had a gain of 0.0004 of a dollar on my trade. It is far more convenient to say that, “I made 4 pips on my GBPUSD trade!” or “The spread on GBPUSD is 2 pips with a bid of 1.6544 right now.”
So What Are Forex Pips in Terms of Actual Dollars in Forex Trading?
The short answer is that in most cases involving the USD as one of the currencies in the cross rate the dollar value per Pip is approximately $10. The more complicated answer is that when the USD is the COUNTER currency the Pip value is exactly $10, when the USD is the BASE currency the Pip value varies with the cross rate, but is still usually AROUND $10.
For example today the USDJPY rate is 82.35 (as in the example we used above). What is the Pip value of the USDJPY cross rate today?
Pip value (in USD terms) = 1 pip / Cross Rate x LOT Size or in this case .01 / 82.35 x 100000 = $12.14 So a one pip favorable movement in the cross rate results in approximately $12 profit per lot held. If trading a mini LOT (10,000 units) the Pip value is 1/10 the value of the Standard LOT Pip value of $12.14, ie. $1.21. If I was holding 20 LOTs of USDJPY and gained 5 Pips my profit would be approximately 5 x 20 x $12.14 = $1214.
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What Would the Rate of Return Be on The Example USDJPY Trade?
If the leverage was 100:1 you would need $20,000 in capital to open the 20 standard LOT position ($2million). A $1214 gain on $20,000 is 6% for your holding period, say a day or a week. Given even the highest rate savings accounts pay only about 1.25% ANNUALLY today, a 6% return for a few days capital investment is a tidy haul. This is one of the major reasons forex trading is so popular amongst day traders.
