A pip is a standardized unit and is the smallest amount by which a currency quote can change. It is usually $0.0001 for U.S.-dollar related currency pairs, which is more commonly referred to as 1/100th of 1%, or one basis point. This standardized size helps to protect investors from huge losses. For example, if a pip was 10 basis points, a one-pip change would cause greater volatility in currency values.
What Is A Pip?
Assume that we have a USD/EUR direct quote of 0.7747. What this quote means is that for US$1, you can buy about 0.7747 euros. If there was a one-pip increase in this quote (to 0.7748), the value of the U.S. dollar would rise relative to the euro, as US$1 would allow you to buy slightly more euros.
- Most currency pairs are quoted to the fourth decimal place. A pip represents the last—and thus smallest—of those four numbers.
- Even though a pip is a very small unit of measurement, forex traders are usually heavily leveraged and even a one pip difference can equate to significant profit or loss.
- Pips are the most basic unit of measure in forex trading.
Understanding Their Effects
The effect that a one-pip change has on the dollar amount, or pip value, depends on the number of euros purchased. If an investor buys 10,000 euros with U.S. dollars, the price paid will be US$12,908.22 ([1/0.7747] x 10,000). If the exchange rate for this pair experiences a one-pip increase, the price paid would be $12,906.56 ([1/0.7748] x 10,000).
In that case, the pip value on a lot of 10,000 euros will be US$1.66 ($12,908.22 - $12,906.56).
Pips are the most fundamental unit of measure used when trading currencies, but you need to know much more to become a successful forex day trader. Investopedia's Become a Day Trader course provides an in-depth look at the skills that you need to succeed as a day trader with over five hours of on-demand video.
If, on the other hand, the same investor purchases 100,000 euros at the same initial price, the pip value will be US$16.6. As this example demonstrates, the pip value increases depending on the amount of the underlying currency (in this case euros) that is purchased.