A:

In forex markets, currency trading is done on some of the world's most powerful currencies. The major currencies traded are the U.S. dollar the Japanese yen, the euro, the British pound and the Canadian dollar.

A currency pair such as EUR/USD, for example, represents a euro and U.S. dollar currency pair. The first currency is the base currency and the second currency is the quote currency. So, to buy EUR/USD at 1.1200 on a trade for 100,000 currency units, you would need to pay US$112,000 (100,000 * 1.12) for 100,000 euros.

Pips relate to the smallest price movement any exchange rate can make. Because currencies are usually quoted to four decimal places, the smallest change in a currency pair would be in the last digit. This would make one pip equal to 1/100th of a percent, or one basis point. For example, if the currency price we quoted earlier changed from 1.1200 to 1.1205, this would be a change of five pips.

[Pips are one of the most fundamental concepts to understand when trading currencies, but there are countless other concepts that day traders need to know to be successful. Investopedia's Become a Day Trader Course will teach you a proven strategy that includes six different types of trades that can be placed using any security in any market.]

To get the value of one pip in a currency pair, an investor has to divide one pip in decimal form (i.e. 0.0001) by the current exchange rate, and then multiply it by the notional amount of the trade.

Keeping with our earlier example for the EUR/USD currency pair, the value of one pip is 8.93 euros ((0.0001/1.1200) * 100,000). To convert the value of the pip to U.S. dollars, just multiply the value of the pip by the exchange rate, so the value in U.S. dollars is $10 (8.93 * 1.12). The value of one pip is always different between currency pairs because there are differences between the exchange rates of different currencies. A phenomenon does occur when the U.S. dollar is quoted as the quote currency. When this is the case, for a notional amount of 100,000 currency units, the value of the pip is always equal to US$10.

To learn more, see Common Questions About Currency Trading, A Primer On The Forex Market and Forces Behind Exchange Rates.
 

RELATED FAQS
  1. Where did the term 'pip' in currency exchange come from?

    Learn the definition of a pip, what it means in the scope of currency exchanges and how to determine its value. Find out ... Read Answer >>
  2. What is a pip and what does it represent?

    A pip is a very small measure of change in a currency pair in the forex market. It can be measured in terms of the quote ... Read Answer >>
  3. How Does Leverage Affect Pip Value?

    Small changes in pip value will result in larger fluctuations in account value. Read Answer >>
  4. How do you make money trading money?

    How someone makes money in forex is a speculative risk: you are betting that the value of one currency will increase relative ... Read Answer >>
  5. Why is currency always quoted in pairs?

    When reading currency quotes, you have probably noticed that there is only a single quote for a pair of currencies. Currency ... Read Answer >>
  6. Why is the U.S. dollar shown on the top of some currency pairs and on the bottom ...

    All currencies are traded in pairs. The first currency in the pair is called the base currency while the second is called ... Read Answer >>
Related Articles
  1. Tech

    The Basics Of Currency Trading

    Trading in the currency market isn't easy. We tell you what you need to know before starting.
  2. Trading

    Spread-To-Pip Potential: Which Pairs Are Worth Day Trading?

    Spreads play a significant factor in profitable forex trading. Learn when it's worth trading and when it isn't.
  3. Trading

    Top 8 Most Tradable Currencies

    Currencies can provide diversification for a portfolio that's in a rut. Find out which ones you need to know.
  4. Trading

    The 6 Most-Traded Currencies And Why They're So Popular

    Every currency has specific features that affect its underlying value and price movements in the forex market.
  5. Trading

    Using Currency Correlations To Your Advantage

    Knowing the relationships between pairs can help control risk exposure and maximize profits.
RELATED TERMS
  1. Pip

    A pip is the smallest price move that a given exchange rate makes ...
  2. Currency Pair

    The quotation and pricing structure of the currencies traded ...
  3. Currency Pairs

    Two currencies with exchange rates that are traded in the retail ...
  4. Currency Pair: EUR/USD (Euro/U.S. Dollar)

    The Currency Pair EUR/USD is the abbreviation for the euro and ...
  5. Quote Currency

    The quote currency is the second currency in both a direct and ...
  6. Major Pairs

    Major pairs are the most traded foreign exchange currency pairs. ...
Hot Definitions
  1. Bubble

    1. An economic cycle characterized by rapid expansion followed by a contraction. 2. A surge in equity prices, often more ...
  2. Swap

    A swap is a derivative contract through which two parties exchange financial instruments, such as interest rates, commodities, ...
  3. Yield Curve

    A yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but ...
  4. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
  5. Risk Tolerance

    The degree of variability in investment returns that an individual is willing to withstand. Risk tolerance is an important ...
  6. Donchian Channels

    A moving average indicator developed by Richard Donchian. It plots the highest high and lowest low over the last period time ...
Trading Center