Before jumping into the exciting world of forex trading, there is quite a bit of terminology and forex related concepts you will need to come to terms with.
For a complete rundown on everything forex, our guide ‘ forex trading for beginners’ is the perfect place to start. To get a better understanding of some of the key terms in that guide like ‘pips’, ‘spreads’ and ‘pipettes’, this article is for you.
Now that you’ve started your journey to understand what is forex trading, we’re going to explain how a pip works, how to calculate a pip and what’s the difference between a pip and a pipette.
But first, we need to start with what spread is in forex. Many beginner traders usually have some questions around spreads and how some accounts have low spreads and some accounts have high spreads, and why that is.
Keep reading and take your time with this information, it is critical knowledge for all new forex traders entering the foreign exchange market.
What is a spread in forex?
A spread is defined as the difference between the bid and ask price of a currency pair. It is usually measured in pips, which is the smallest unit of price movement of a currency pair.
Spreads are not unique to forex as many other markets use this term to calculate the difference between the bid and ask price, including indices, commodities and cryptocurrency to name a few.
To see forex spreads in action, check out our live forex rates and watch the difference in spread between standard and pro accounts in real-time.
How to calculate spread in forex?
Before looking at any spread, a beginner trader must understand the concept of bid and ask price.
The “bid” is the price at which you can sell the base currency, whereas the “ask” is the price at which you can buy the base currency. The bid and ask prices can be found inside the MetaTrader 4 trading platform.
As seen in the image above, GBP/USD has a bid price of 1.30523 and an ask price of 1.30533.
Given that 1 pip in a GBP/USD pair is in the 4th decimal place (0.0001), this would mean that this GBP/USD quote has a 1-pip spread.
What is a pip in forex?
A pip is the standardised unit measuring a change (both gains and losses) of a currency pair in the forex market. It is the smallest increment in value of an exchange rate between a currency pair.
A pip, also known as a “point” in currency trading, is worth 1/100th of one cent on most exchanges. Forex traders typically use pips to calculate profits and losses when dealing with foreign exchange transactions.
What does pip stand for?
‘Pip’ can stand for ‘percentage in point’ or ‘price interest point’ within the forex market.
How do pips work?
A pip measures the amount of change in the exchange rate of a currency pair, calculated using its 4th decimal (in JPY pairs, it is calculated using the 2nd decimal).
It is important to note that pips do not represent any actual cash value — that depends on the position size of the trade, which would affect the pip value.
Example of a pip using a major currency pair
In the EUR/USD currency pair, pip movement from 1.1080 to 1.1081 is an increase of 1 pip.
Example of a pip using a Japanese Yen currency pair
In the USD/JPY currency pair, pip movement from 10.44 to 10.43 is a decrease of 1 pip.
What is a pipette in forex?
Pipettes are fractional pips. It is 1/10 of a pip, usually calculated using the 5th decimal (in JPY pairs, it is calculated using the 3rd decimal).
Example of a pipette using a major currency pair
In the EUR/USD currency pair, a movement from 1.10811 to 1.10812 is an increase of 1 pipette.
Example of a pipette using a Japanese Yen currency pair
In the USD/JPY currency pair, a movement from 10.433 to 10.432 is a decrease of 1 pipette.
What is the pip value?
A pip value is defined by the currency pair being traded, the exchange rate of the pair and the size of the trade.
The pip value is usually referred to when referencing the performance of a position to attribute price to a forex trade, whether it’s a loss or gain.
How to calculate the value of a pip?
The calculation to find the pip value is:
Divide one pip by the current price of the forex currency pair and multiply that number by your lot size (the number of base units you are trading).
Due to the variation in exchange rates, the value of a pip will be different across currency pairs.
What is the difference between a pip and a pipette?
A pip relates to movement in the fourth decimal place while a pipette is used to measure movement in the fifth decimal place. A pipette is a ‘fractional pip’ as it equals a tenth of a pip.
When looking at the difference between pip and pipettes in currency pairs involving the Japanese Yen, the pip relates to the second decimal point, and the pipette is the third decimal point.
How many pips a day do forex traders make?
There is no set amount of pips you can make daily, and will depend on your technical and fundamental analysis, your trading style and the way in which the market moves.
All traders want everyday to be profitable but in the real world that doesn’t exist as forex trading is very much a high risk game. Stick to your trading plan, trial and innovate new strategies and practice proper risk management techniques.
What are ticks and points?
A ‘tick’ is similar to a pip, but it may not measure every increment equally. For example, a tick on one instrument may be measured in increments of 0.0001 whereas another instrument may be measured in increments of 0.25.
A tick is simply the smallest increment a particular instrument can move in, and the terminology is usually used in securities or indices trading.
A point is another unit of measurement, used when there is a shift in the dollar amount. For example, if a share price went from $25 to $30, traders would say it has moved 5 points.
This term is also used in forex in place of ‘pipette’, to refer to the movement of the 5th decimal place.
Final thoughts
Please do note that most forex brokers offer at least two different account types, like we do at Axi.
Standard accounts will typically have all costs included in the spread. For example, if you trade EUR/USD on a standard account, you might be charged a spread of 1 pip, which is the total cost of opening the trade.
Other account types (and the name of those vary from broker to broker) might have very low spreads — as low as 0.0 — but place a commission charge instead.
For example, if you trade EUR/USD on such an account, you might not pay any spread (i.e. zero spread), but will be charged a certain $ amount per lot traded.
Therefore, it is important to carry out your own research and determine which broker will be best for you. Find out more on how we keep our spreads low!
The information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. Readers should seek their own advice. Reproduction or redistribution of this information is not permitted.
Originally published at https://www.axi.com.
