How Pip Values Are Calculated in Forex
02/04/2009 1:04 pm EST
A forex pair moves in increments called pips. The pip, in most cases, is the fourth decimal place(or the ten-thousandths place) in the quoted exchange rate. If the exchange pair is quoted in Japanese yen, then a pip is a change in the second decimal place (or hundredths place) in the exchange rate. A change of a single pip has a value, and in the case of most of the majors quoted in US dollars, that value is $10 per pip per full size lot. Other currency pairs without the USD in the quote position will have different pip values. This article will explain how pip values are calculated and why that matters.
The EUR/USD represents 100,000 euros, which can buy 129,820 dollars at today's exchange rate of 1.2982. Therefore, the EUR/USD currency pair could be expressed as 100,000 EUR/129,820 USD. If you were long the EUR/USD, and it moved up by one pip to 1.2983, you have earned $10. You can see the difference by restating the pair as 100,000 EUR/129,830 USD. The amount of USD has grown on the right side of that equation by $10—the value of the pip.
However, crosses that don't have the USD on the right hand side of the equation are a little trickier. For example, the EUR/GBP represents 100,000 EUR/90,800 GBP at today's exchange rate of .9080. If the pair moves up one pip to .9081, then a trader holding the pair long would have made ten pounds per pip, not ten dollars like in the EUR/USD scenario above. However, if we convert those ten pounds into dollars at the current GBP/USD exchange rate of 1.4279, we get a pip value of $14.27 per pip.
This was not just an intellectual exercise to answer a curiosity. Knowing that pips have different values and accounting for those as you plan your trades is important to keep yourself from getting overweight in any single currency pair. For example, if you were planning similar trades on the EUR/USD and the EUR/GBP, you should account for the fact that a 50-pip stop loss or 200-pip target is 50% more valuable on the EUR/GBP because its pip value is almost 50% higher than the pip value of the EUR/USD. Not considering the value of your possible profits or targets could lead you to unintentionally take riskier positions on a cross than on the USD quoted majors by trading equal number of lots, which will introduce volatility into your account.