What Is A Pip In Forex? Understanding The Forex Basics

Traders come across many terms in the forex markets. As a trader, one of the most common terms you will come across is ‘pip.’ At this point, you may ask, ‘What is a pip in forex?’ A pip in forex refers to the percentage in point movement of a currency pair. Pips enable traders to assess the spread of a particular currency pair. It also allows them to assess the gains and losses on an open position.

In this guide, we will attempt to understand what is a pip in forex. We will look at several things, such as how to use pips when trading Forex. We will also look at where you can trade Forex with tight spreads. Let’s get started.

What Is A Pip In Forex? Key Points 

In this section, we list the key points to answer the question – what is a pip in forex?

• The foreign exchange market is a global marketplace that facilitates the exchange of currencies. 
• Currencies trade against one another as exchange rate pairs. The EUR/USD pair is the currency pair to trade the euro against the US dollar. 
• Forex markets can exist as spot and derivatives markets. These markets offer several financial instruments, such as futures, forwards, currency swaps, and options. 
• Forex is the world’s largest and most liquid asset market. This is thanks to the global reach of trade, finance, and commerce. 
• Some traders use Forex to hedge against international currency and interest rate risk. They also use it to speculate on geopolitical events and diversify portfolios.

What Is The Forex Market?

The forex market is the market where currencies are traded. Forex markets are unique because they lack a central marketplace. Instead, all currency trading is conducted electronically, over-the-counter (OTC). All transactions in the forex market happen among traders through computer networks instead of a centralized exchange.

Forex markets are open 24 hours a day, five and a half days a week. Currencies are traded across all major financial centers, such as Frankfurt, Tokyo, Sydney, Singapore, Paris, New York, and Zurich. The markets start from Tokyo and Hong Kong when the trading day in the US ends. This means forex markets are always active, with prices changing constantly. Forex brokers act as market makers and post bids and ask prices for a currency pair that differs from the most competitive bid in the market.

Forex markets are comprised of interbank level and over-the-counter (OTC) markets. Large banks trade in the interbank market. These trade currencies for several purposes, such as hedging, balance sheet adjustments, and on behalf of their clients. Individual traders trade in the OTC market through online brokers and platforms. From Monday morning in Asia to Friday afternoon in New York, the forex market functions for 24 hours. The markets open from 5 PM EST on Sunday to 5 PM EST on Friday.

This differs from other markets, such as bonds, equities, and commodities. All these markets close for a specific amount of time, generally in the afternoons. However, there are some exceptions. For example, some emerging market currencies close for a few hours during the trading day.

78% of retail investor accounts lose money when trading CFDs with this provider.

History Of The Forex Market 

Currencies were earlier pegged to precious metals such as gold and silver. However, this changed after World War 1. However, by the Second World War, the system had collapsed entirely and was replaced by the Bretton Woods agreement. The Bretton Woods Agreement resulted in the creation of three organizations to oversee and facilitate economic activity across the world. These organizations were 

• The International Monetary Fund (IMF)
• International Bank for Reconstruction and Development (IBRD)
• General Agreement on Tariffs and Trade (GATT)

This system also replaced gold with the US Dollar as the peg for major international currencies. As such, the United States government promised to back up the Dollar value with equivalent gold reserves. However, the Bretton Woods agreement became redundant in 1971 when President Nixon temporarily suspended the dollar’s convertibility into gold. Today, currencies can choose their own peg, with their value determined by supply and demand in the international markets.

Types Of Forex Markets 

Forex is generally traded through spot, forward, and futures markets. The spot market is the largest of the three. This is because it is the underlying asset upon which the other two markets are based. When discussing the forex market, investors generally refer to the spot market. The forwards and futures markets are more popular with institutions that need to hedge their foreign exchange risks to a specific future date. Let’s take a quick look at each market type.

Spot Market 

The spot market is where traders buy or sell currencies based on their trading price. The trading price is determined by factors such as supply and demand and is calculated based on the following, 

• Economic performance
• Current interest rates 
• Price speculation 
• Geopolitical developments 

A final deal on the spot market is called a spot deal. A spot deal is a financial transaction between two parties. One party delivers an agreed-upon currency amount to the other party while receiving another currency at the agreed exchange value. Once the position is closed, it is settled in cash. 

While the spot market is known for dealing in transactions between two parties in the present, the trades often take a couple of days or more to settle. The key players in the spot market are commercial, investment, and central banks. The market also consists of dealers, brokers, and speculators. Large commercial banks generally make up a large chunk of the spot market, trading for themselves and their customers.

Futures Market 

The futures market is similar to forward markets regarding basic functioning. However, there is a key difference. The futures markets use centralized exchanges. Because of the use of centralized exchanges, there is no counterparty risk. This ensures that futures markets are highly liquid when compared to forward markets.

Let’s understand a futures contract. A futures contract is a standardized agreement between two parties to take delivery of a particular currency on an agreed future date and at a pre-determined price. Futures are generally traded on an exchange and not over-the-counter. Trading Futures contracts are bought and sold on a standard size and date on commodities markets such as the Chicago Mercantile Exchange (CME).

Futures contracts include specific details such as the number of units traded, delivery and settlement dates, and minimum price increments.

Forwards Market 

Let’s understand how the forwards market works. In this market, two parties agree to trade a currency at a set price and quantity in the future. No currency is exchanged when the trade is initiated. The transacting parties can be companies, individuals, or governments.

However, the forward markets lack centralized trading and are known to be relatively illiquid. Thanks to the lack of a centralized agency, there is also the specter of counterparty risk.

Using The Forex Market 

Currencies have two distinct characteristics when used as an asset class. These are, 

• Traders can earn the interest rate differential between two currencies. 
• Traders can also profit from differences in the exchange rate. 

This means you can profit from the difference between interest rates in different economies. This can be done by purchasing the currency with the higher interest rate and shorting the currency with the lower rate. Let’s understand this with the help of an example. Before the financial crisis of 2008, shorting the Japanese yen and purchasing the British pound was relatively common. This is because the interest rate differential was considerable. This strategy was referred to as a carry trade.

Hedging

Companies operating in foreign markets face risks due to fluctuations in currency value when buying or selling goods. Forex markets give these companies a way to hedge currency risk by fixing a rate at which the transaction would be completed. Traders can purchase or sell currencies in the forward and swap markets in advance, locking in the exchange rate.

Locking the exchange rate helps traders minimize losses or increase gains. This depends on which currency in a pair is strengthened or weakened.

Speculation 

The supply and demand of a currency is influenced by several factors, such as interest rates, tourism, trade flows, economic strength, and geopolitical risks. This creates daily volatility in the forex markets. Traders can use this volatility to profit from small changes that could increase or decrease the value of a currency.

Predicting that one currency will weaken automatically means the other currency in the pair will strengthen. A trader can anticipate the price movements and short or long one of the currencies in the pair and make a profit.

A Brief Definition 

Now that we have a clear idea of forex markets, let’s move ahead in our guide on understanding what is a pip in Forex.

So, what is a pip in Forex? Simply put, a pip is an acronym for ‘percentage in point.’ Traders can utilize pips to refer to the price movement of a forex pair. Pips are required in the space because forex pairs change by micro units several times in a trading day.

A single pip is a basis point, 1/100th of a percentage. This means if the price of the GBP/USD trading pair increases by 0.01%, it represents a positive movement of 1 pip. However, if the GBP/USD pair declines by 0.04%, it means a negative movement of 4 pips.

Conventional currency pairs typically have four digits after the decimal point. However, this information must be displayed when searching for the exchange rate on Google. Instead, the information on Google displays only two digits after the decimal, like 1.15. However, if you are using a forex broker to trade GBP/USD, the exchange rate would be displayed as 1.1570.

Pipettes

Some forex brokers also use pipettes, meaning five digits after the decimal point are displayed. This means the exchange rate would look like this: 15.15701. Using pipettes makes Forex trading even more affordable for a casual trader. Traders utilize pips for several reasons. When assessing how a forex broker is priced, traders generally view the spread in terms of pips. If EUR/GBP is available at a buy price of 1.0011 and 1.0012, the spread is 1 pip.

Pips also help traders gauge profit and loss. For example, if a trader goes long on GBP/USD at 1.1500 and cashes out at 1.1570, it means they have generated gains worth 70 pips. If the trader stakes $10 per pip, it represents gains of $700.

Understanding Pips In Forex 

Let’s move ahead in our guide on what is a pip in Forex. If you are a beginner, you must understand pips in Forex before you start trading. This will help you assess micro-currency movements when it comes to profit and loss. It also helps evaluate the competitiveness of the spread. This section of our guide on what a pip in Forex is will look at the basic fundamentals of pips.

An Indicator Of Price Movements 

As mentioned above, a pip simply refers to a basic point. A single pip equals 1/100th of a percentage. This means each percentage movement accounts for 100 pips. This means if a forex pair moves by 3%, it can also be called a 300 pip gain.

Forex brokers usually display currency prices with four digits after the decimal point. For example, if the GBP/USD pair is trading at 1.1473 and drops to 1.1470, it represents a decline of 3 pips.

However, there are some exceptions to this rule. For example, trading pairs containing the Japanese yen have only two digits after the decimal point. This means if the USD/JPY pair moves from 140.56 to 140.60, it represents an increase of 4 pips.

The second exception is that some brokers display five digits after the decimal point or three in pairs with the JPY. The additional unit at the end of the price shown is called the pipette.

Let’s understand how pipettes work with the help of an example. If the GBP/USD pair increases from 1.14730 to 1.14739, it represents a positive movement of 9 pipettes.

Pips And Forex

Next in our guide on what is a pip in Forex is understanding pips and spreads. A majority of online brokers display their spreads in pips. As mentioned earlier, the spread is the difference between a forex pair’s buy and sell price.

This is why forex trading platforms display two prices. For example, in the screenshot shared below, the EUR/USD pip value is at a buy price of 0.99164. The sell price of the pair is at 0.99158. This means the difference between the prices displayed is 6 pipettes. However, most online forex brokers would display this as 0.6 pips.

Let’s consider another example. Let’s assume the buy and sell prices of USD/CAD are 1.31650 and 1.31630. In this scenario, the spread is 20 pipettes or 2 pips. Such a value may be viewed as high for a pair like the USD/CAD. Major pairs generally come with the tightest spreads, while minor and exotic pairs are less competitive. The more volatile the forex pair, the higher the spread.

Slippage 

When forex traders discuss slippage, it is almost always viewed in terms of forex pips. Let’s understand slippage first. Slippage occurs when the trader gets a different price than the one they placed the order. This generally happens when placing a market order because the pair could change value in the time taken to place the order. Let’s understand slippage with the help of a simple example.

Let’s assume the forex trader is looking at the EUR/CHF trading pair. The trader decides to go long and places a market order at 0.97525. Once the order is placed, the broker executes the order instantly at the next best available price. However, the trader fills the order at 0.97529. This results in a loss of 0.2 pips thanks to slippage.

As a trader, you can avoid slippage in several ways. The best way is to place limit orders. This allows you to specify the price at which the broker must execute the position.

Profit And Loss 

Next in our guide on what is a pip in Forex is profit and loss. Some traders calculate and report their profit and loss in pips. This allows them to get a bird’s eye view of their performance over the month. To do this, the trader must keep track of their stake per pip. Let’s understand this with an example. Suppose a trader goes long on the EUR/USD trading pair at 0.99000.

The trader also decides to stake $10 per pip. After placing the stake, the price increases to 0.99800. This increase represents an increase of 80 pips. Since the trader had initially staked $10 per pip, this increase resulted in a profit of $800. However, there are more efficient ways than using pips to calculate profit or loss. The best way to calculate profit and loss is to view them in terms of percentage. A trader must consider several factors, such as spreads, stakes, and leverage.

How To Use Pips In Forex Trading 

Next, in our guide on what is a pip in Forex, we will understand how to use pips. First, what is a pip used for? To understand this, it is crucial to understand how forex lots function. When banks and other financial institutions trade currencies with each other, they do so using lots. Each lot consists of 100,000 units of the base currency from a pair. Let’s look at a few examples to understand lots better. 

• GBP/USD – In this pair, the base currency is GBP. As such, 1 lot of GBP/USD would equal £100,000. 
• EUR/USD – In this pair, the base currency is EUR. This means 1 lot of EUR/USD would equal €100,000. 
• USD/CAD – This trading pair has the base currency as USD. This means 1 lot of USD/CAD would equal $100,000. 

Retail clients do not trade Forex in lots. Instead, retail traders generally trade micro-lots. Micro-lots are equal to 1% of a lot. For example, a USD/CAD pair micro-lot would equal $1000. But why is this relevant in our guide? It is relevant because micro-lots and smaller stakes are also being traded. Pips enable traders to assess the price movement of a specific currency pair. Next, let’s look at calculating forex pips based on the lot size.

Pip Value Calculator 

In this section of our guide on what is a pip in Forex, we will look at pip value calculators and their uses. There are several forex pip calculators available online. Most of these are offered by online brokers.

As a trader, all you have to do is enter the trade details, such as the lot size and the trading pair. Once entered, the calculator will display the pip value for that specific trade. However, you must understand how the data is generated before using a pip calculator.

To understand this, let’s look at a couple of examples.

USD/CAD 

Let’s begin with USD/CAD. Currently, this currency pair is trading at 1.3714. This means for every 1 USD, you receive 1.3714 CAD. Remember, the standard lot for the USD/CAD trading pair is 100,000 units or $100,000. As such, the pip calculation is as follows,

USD/CAD FX rate – 1.3714: (.0001/1.3714) x 100,000 = $7.29

According to the calculations, each pip movement when trading the USD/CAD currency pair is worth $7.29.

78% of retail investor accounts lose money when trading CFDs with this provider.

GBP/USD 

Let’s look at another trading pair, the GBP/USD. At the time of writing, the GBP/USD trading pair. Currently, the currency pair is trading at 1.2161. This means for every 1 GBP, you receive 1.2161 USD. As in the example above, the standard lot of GBP/USD amounts to 100,000 units, or in this case, £100,000. So, the calculation will be as follows.

GBP/USD FX rate – 1.2161: (0.001/1.2161) x 100,000 = $8.22.

This means that each pip movement when trading the GBP/USD pair is worth £8.70.

How To Start Trading Forex 

Trading forex is quite similar to equity trading. Let’s look at how you can start your forex trading journey. 

• Learn about Forex – Forex trading is not complicated. However, it requires specialized knowledge and a commitment to learning. 
• Create a brokerage account – You will need a forex trading account at a brokerage to start trading. Our recommendation for an online broker is eToro. 
• Develop your trading strategy – It isn’t always possible to predict or time the market or price movements. A trading strategy will help you create a clear road map and execute your trades promptly. 
• Check positions – Once you start trading, it’s always a good idea to check your positions at the end of the day. Most trading software provides a daily account of all trades. Ensure you do not have any pending positions that need to be filled and that you have sufficient funds for future trades. 
• Discipline – Forex trading may be quite overwhelming for a beginner. Discipline yourself and your trading to ride out market upheavals and close positions when needed.

Where Can You Trade Forex With Tight Spreads 

Next, in our guide on what is a pip in Forex, we will look at where you can trade Forex with competitive spreads. Let’s recap a bit before we move ahead. We’ve already discussed that a pip helps assess how competitive the spread of a particular forex pair is. The pip will be as per the broker offering the respective market.

This section of our guide will look at the best trading platforms where you can trade Forex at tight spreads. Let’s get started.

1. eToro 

eToro has over 30 million clients, making it one of the most popular forex brokers in the market. Traders on the platform can create an account within minutes and deposit a very reasonable minimum deposit. The minimum deposit for clients based in the US and UK is just $10. Meanwhile, those based in other regions require a minimum deposit of $50. eToro does not charge a deposit fee when accounts are being funded in USD.

The platform also accepts several payment methods, including bank wire transfers, debit/credit cards, Paypal, Skrill, Neteller, and others. Traders can also access swap-free accounts.

A standard eToro account lets traders access the forex markets across 49 currency pairs. All trades are executed spread-only, starting from 1 pip per slide on EUR/USD. Traders can also access leverage, with retail clients accessing leverage up to 1:30 and 1:20 on major and minor/exotic pairs, respectively. The minimum trade size is 1000 currency units or 0.01 lots.

If a trader enters a $1000 position on the EUR/USD pair with leverage of 1:10, they would need to stake just $100. eToro also supports negative account balances, a crucial offering for beginners. eToro is also heavily regulated by the SEC, CySEC, and the FCA.

eToro Features 

Beginners and casual traders can also access eToro’s flagship feature, Copy Trader. Copy Trader allows traders to copy the trades of highly successful traders on the eToro platform. Once a trader has been selected, you can mirror their trades and investments into your portfolio. However, copy trading requires a slightly higher outlay of $200.

You can also access Smart Portfolios on eToro. Smart portfolios are professionally managed and rebalanced on your behalf. Apart from Forex, eToro also offers stocks, ETFs, and crypto.

What We Like About eToro 

• Highly regulated platform
• USD deposits do not attract a deposit fee. 
• Offers Copy Trading tools and Smart Portfolios 
• Low trading commissions 
• The platform supports several payment methods, such as bank transfers, e-wallets, and debit/credit cards.

78% of retail investor accounts lose money when trading CFDs with this provider.

2. Capital.com 

Capital.com is another excellent option when it comes to forex trading. The platform is highly regulated and offers access to thousands of markets. These markets are represented as contracts-for-differences or CFDs. This offering includes over 138 forex pairs and stocks, indices, hard metals, ETFs, energies, and cryptocurrencies.

The platform is ideal for trading Forex without blowing a hole in your account for several reasons. The first is the minimum deposit. When making a debit/credit card or e-wallet deposit, the minimum requirement is set at just $20. However, bank deposits have a higher minimum requirement of $250. Capital.com also offers traders micro lots. This means you can trade 0.01 of a standard lot, which is also equal to 1000 currency units.

The platform also offers highly competitive spreads starting at 0.6 pips on the EUR/USD pair. There are also no forex commissions on Capital.com.

Features And Leverage

The CFD broker offers traders access to two trading platforms. The first option is Capital.com’s native web-based and native mobile platform. The mobile platform is compatible with both Android and iOS. The second option is connecting Capital.com to MetaTrader 4 (MT4). This option is ideal for traders who are in the market for a pip value calculator. MT4 allows Capital.com users to assess the value of a pip without performing any manual calculations.

Traders on Capital.com can access leverage of up to 1:30 on major pairs. Those wishing to trade minor or exotic pairs can access leverage of up to 1:20. Traders can enter both long and short positions, allowing them to speculate on rising and falling currency trends.

Capital.com is also known for its educational resources and materials. The platform offers everything from forex trading videos, guides, financial news, market insights, and an economic calendar. Creating an account on Capital.com takes less than five minutes. All you have to do is create and verify your account by submitting the requisite documents. As mentioned earlier, Capital.com is highly regulated and authorized by the FCA, ASIC, NBRB, and CySEC.

What We Like About Capital.com 

• Capital.com is a commission-free platform. 
• Offers support for MetaTrader 4
• Has a plethora of educational materials and resources
• The platform is highly regulated, ensuring the security of customer assets and information.

Major Players In Forex 

The most traded currency in the world is the US Dollar, followed by the euro and the Japanese yen. Meanwhile, the largest trader in the forex market is JPMorgan, with a 10.8% global market share. Next is UBS, which holds 8.1% of the forex market. Citigroup, XTX Markets, and Deutsche Bank hold the remaining top positions in the market.

Advantages And Disadvantages Of Forex Trading

Forex markets and trading have several advantages. However, they also have their disadvantages. Let’s quickly go over them.

Advantages 

One of the most significant advantages of forex trading is its lack of restrictions and flexibility. Trading volumes are substantial, and the market is open nearly 24/7. This means that regular people can also participate in trading at night or on weekends. This is different from the stock market, where trading hours are restricted.

Additionally, the forex market also offers a significant number of trading options. There are hundreds of currency pairs in the market and various agreements such as futures and spot. Transaction costs are generally low compared to other markets. Additionally, the leverage is the highest in all the available financial markets. High leverage can significantly magnify gains but also losses.

Disadvantages 

Forex markets offer high leverage, which could magnify gains. However, increased leverage could also amplify losses. The leverage offered in forex trading is 20-30 times and offers outsized returns or significant losses. The markets are open nearly 24/7, which is good news for some traders. However, this also means traders may have to use trading programs or algorithms to protect their investments. This leads to operational risks and increases costs.

The other disadvantage of forex trading is counter-party risk. Regulating forex markets is quite tricky, given they trade almost constantly. However, there is no central exchange that guarantees trade. This means there is always the risk of a default from one party.

Forex Terminology 

The best way to get started with forex trading is to learn its terminology. Let’s look at some of the essential terms you must remember. 

• Forex Account – A forex account lets you make currency trades. There are three types of forex accounts depending on the lot size.
• Micro Forex Accounts: Micro forex accounts let you trade up to $1000 worth of currencies in one lot. 
• Mini Forex Accounts: These accounts allow you to trade up to $10,000 worth of currencies in one lot. 
• Standard Forex Accounts: Standard accounts allow you to trade up to $100,000 worth of currencies in a single lot.
• Ask – An ask is the lowest price you are willing to purchase a currency. 
• Bid – The bid is the price you are willing to sell a currency. 
• Contract For Difference – A contract-for-difference (CFD) is a derivative that allows traders to speculate on price movements for currencies without owning the underlying asset. 
• Leverage – Leverage refers to borrowed capital that multiplies returns. Forex market offers high leverage that allows traders to boost their positions.

Charts In Forex 

Traders trading forex primarily use three types of charts. 

Line Charts 

These charts are utilized to identify and keep track of big-picture trends of a currency. Line charts are the most basic and common charts used by forex traders. These charts display the closing price for a currency for the period specified by the trader. Trend lines in a line chart help in creating forex trading strategies. For example, traders can use the trend lines to identify changing trends or breakouts.

A line chart is generally used as a starting point to conduct further trading analysis.

Bar Charts 

Bar charts provide traders with more information than line charts. Each bar chart represents one day of trading and contains the opening, highest, lowest, and closing prices for a trade. Bar charts help traders identify if it is a buyer’s or seller’s market.

Candlestick Charts 

Japanese rice traders first used candlestick charts in the 18th century. These charts are visually more appealing and easier to read than other chart types. The upper portion of the candle represents the opening and highest price point of a currency. The lower portion of the candle represents the lowest and closing price point. The shapes and formations in a candlestick chart help traders identify price movements and market direction.

Are The Forex Markets Volatile 

The forex markets rank among the most liquid markets in the world. This means they are considerably less volatile than other markets, such as real estate and finance. Volatility in a currency is subject to several factors, such as economics and geopolitical developments. Events such as a payment default or a trade imbalance could result in considerable volatility.

Are Forex Markets Regulated 

Regulation of forex markets depends on the jurisdiction in which the market is operating. The United States has a robust infrastructure and markets in place for forex trading. The National Futures Association (NFA) and the Commodity Futures Trading Commission (CFTC) regulate the forex market and forex traders.

Because of the use of leverage in Forex, markets such as India and China have introduced considerable restrictions on the firms and capital used in Forex. The largest forex market for forex trades is Europe. Meanwhile, the market is regulated by the Financial Conduct Authority (FCA) in the United Kingdom.

What Currencies Can You Trade 

Currencies with high liquidity have a ready market and a predictable price response to external market events. The most traded currency in the world is the US Dollar. The currency is paired in six of the seven most liquid currency pairs. However, currencies that are low in liquidity cannot be traded in large lot sizes without significant market movement associated with the price.

What Is A Pip In Forex – Conclusion

Understanding of what is a pip in forex when entering the market is crucial, especially when assessing how competitive brokerage spreads are. The forex market offers several advantages, such as flexibility and high leverage. While leverage can significantly magnify gains, it can also lead to major losses.

eToro is an excellent forex broker to start your forex trading journey. The platform has over 30 million users, and you can create an account within minutes. The minimum deposit for UK-based clients is as low as $10, while clients from other regions must deposit just $50. The platform also offers high leverage, with spreads starting from 1 pip.

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• Free Copy Trading of Professional Traders
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• Minimum Deposit only $10

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75% of retail investor accounts lose money when trading CFDs with this provider.

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Author: Kamal Masri

Kamal is an experienced financial analyst with a demonstrated history of working in the Financial Market. Skilled in Equities, Capital Markets, Portfolio Management, Risk management, and Corporate Finance. Kamal has worked at some of the leading online finance publications providing his expert knowledge on cryptocurrency. Kamal has written widely on digital assets across the stock and crypto media space and beyond, including for Coindesk, Ethereum World News and The FinTech Times.

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