What is a Pip? Pips and Leverage: Key to Forex Success

Key Takeaways:

• A pip is the smallest unit of Forex trade, typically 0.0001 for most currencies.
• Your pip value will be different based on currency pair and your position size (lot size).
• Leverage is when you are able to trade with larger positions but more risk.
• You must understand pips, lot sizes, and leverage so that you can manage your trades correctly.

Foreign exchange trading, or Forex trading as it’s come to be popularly known as a fluctuating market for money wherein currencies are selling hand over fist. It is frightening enough to get started by the newbie amidst all the cyber-age terminology and jargon. But one concept that stands central to Forex trading is the pip. If you are just starting out trading, or even just need a quick course reminder, then it is definitely worth your while to learn what a pip is and how that will affect your losses and profits.

This article will familiarize you with pips, how they affect your trade, and by way of examples, make you comfortable working with them in real-life trading situations. We also discuss the history of Forex trading and how it evolved over time.

A Brief History of Forex and Pips

First, let us study the history of Forex trading so that we can study the value of a pip.

The foreign exchange market is as old as anything else. Today’s Forex market began to take shape after World War II. In 1944, the Bretton Woods Agreement was inked by 44 countries and they created an international money system under which a majority of the currencies were fixed against the United States dollar. It was a system of fixed exchange rates, and stabilization of world trade and investment was its outcome. The system broke down during the early 1970s, and countries began to use floating exchange rates where currencies were no longer pegged on the dollar. Currencies are then allowed to float based on demand and supply.

It was during this time that the Forex market began expanding and picking up increasing amounts of trade. With the expanding market, though, it became apparent that there needed to be a standard unit of price movement with which the changes could be quantified by traders. It was therefore the pip that was created to enable easy computation of profit and loss by traders, and this was the basis for currency trading in the modern era.

What is a Pip?

In Forex, a pip (short for “percentage in point”) is the smallest price movement unit in a currency pair. A pip is the price value difference between two currencies in a pair. For example, in the currency pair EUR/USD, the pip would typically be 0.0001. So, when the price moves from 1.1000 to 1.1001, it’s a 1 pip move.

Example: GBP/USD bid price: 2.0404. GBP/USD ask price: 2.0408. The difference here is 4 pips. Thus when the price moves, the pips automatically become a gain or loss depending on whether it is a sell (short) or buy (long).

How Pips Impact Your Trades

Pips impact your trades directly. Let us make it clear:

• Example 1: Going Long (Buying): Suppose you buy (go long) GBP/USD at 2.0400. If the price increases to 2.0450, you make 50 pips. But if the price falls to 2.0350, you will lose 50 pips.
• Example 2: Selling (Going Short): Conversely, if you sell GBP/USD at 2.0400 and the price drops to 2.0350, you’ve earned 50 pips. If the price rises to 2.0450, you’ve lost 50 pips.

Quick Reminder:

• Buying (going long) will make you profit if the price rises.
• Selling (going short) will make you profit if the price drops.

How Much is a Pip Worth?

The pip value is calculated using two significant variables: the exchange rate and how big your trade is.

To calculate the pip value, use the formula below:

1 pip ÷ exchange rate = pip value

Let’s say you are trading USD/CHF, for example. If the exchange rate is 1.0810, one pip is:

0.0001 ÷ 1.0810 = 0.00009250 USD.

This might seem like nothing, but the real impact is felt when you start to include the size of the lot.

What Are Trading Lots?

Forex trading doesn’t bother with the purchase or sale of one unit of currency. Instead, you buy and sell in “lots,” which is a predetermined amount of currency. Lot sizes will determine how much you will gain or lose per pip movement. Standard Forex lot sizes are:

• Standard Lot = 100,000 units of money.
• Mini Lot = 10,000 units of money.

Pip Value Dependent on Lot Size

The lot size will determine the amount you gain or lose on each pip move. Two examples follow:

• Mini Lot (10,000 units on GBP/USD): Suppose a pip is worth $0.0001, and you’re dealing in 10,000 units (a mini lot), then the pip value would be: 0.0001 USD×10,000=1 USD per pip.0.0001.Therefore, a 50 pips movement in a mini lot would be equal to a profit or loss of $50.
• Standard Lot (100,000 units on GBP/USD): For a standard lot, the value of one pip would be: 0.0001 USD×100,000=10 USD per pip.

How Leverage Magnifies Pip Movements

You might be thinking: “How am I going to be able to trade such big positions if I don’t have this type of money?” The answer is leverage. Leverage allows you to control bigger positions with a small deposit. It allows you to trade more money than you would otherwise. For example: leverage ratios can be: 

• 100:1 leverage is where you’re trading $100 for every $1 in your account.
• 400:1 leverage is where you’re trading $400 for every $1 in your account.

To trade a mini lot size of $10,000 with a 100:1 leverage ratio, you’d only need to have $100 in your account to open the position.

Notice that the potential for profits (or losses) grows with the lot size and leverage applied in the trade. Use it wisely, and always manage your risk.