What Are Forex Pips and How Do You Use Them to Earn in Forex Trading?

Changes in foreign exchange currency rates can impact many aspects of daily life, and developing a better understanding of these changes is crucial not just for trading but for other activities. For example, the Indian currency depreciation has recently affected the prices of the newest iPhone releases, widening the price gap of the premium Pro versions due to the Indian rupee’s price against the US dollar. In the year 2022-23, the rupee depreciated almost 8% against the dollar, performing worse than many Asian currencies.

Similarly, movements in commodity prices and dollar gains are never a good combination for local currency. Amidst disruptions in global supply chains causing volatility in the currency market, the Reserve Bank of India recently intervened by dipping into its forex reserves, impacting exchange rates against other currencies and other markets such as imports and exports.

With so many numbers and factors to track when forex trading, forex traders rely on forex pips to track price movements in the market and adjust their trading strategies accordingly. A “pip” is an acronym for “percentage in point” or “price interest point” — the smallest whole unit price move that an exchange rate can make.

Today, people use online trading apps to trade forex and track changes in almost 100 currency pairs on the go through the global forex market. Most reliable trading platforms offer insights into forex pips that measure important elements of currency pairs, such as average spread, long swap, short swap, and stop level. Understanding these different pip values can inform traders of the cost of entering a trade, as well as potential gains and losses over time.

Why do pips matter to traders?

Understanding forex pips is crucial for forex traders as they serve as a fundamental unit of measurement for price movements in the forex market. Monitoring changes in pip values can help traders analyse market trends and potential entry or exit trade points.

This is crucial for developing and adjusting trading strategies to avoid potential losses. A vital part of maintaining a trading strategy is choosing the correct times for trading and watching the global economy and its impact on local currency sentiments. While these may seem like abstract concepts, taking the time to understand forex pip values can help provide a clearer numerical view of market movements. This can help traders better calculate potential profit and loss and determine the appropriate position size for a new trade.

More importantly, pips allow traders to compare currency pairs by directly comparing pip movements. This helps traders compare the volatility of different currency values so they can adjust trading strategies and risk assessment accordingly. Traders also typically calculate profits or losses in pips, helping them assess the effectiveness of their trading strategies so they can make smarter and better decisions in future trades.

Recently, India announced it would allow residents to trade currency derivative contracts popular in the offshore market. Local lenders are permitted to offer non-deliverable forwards (NDFs) to onshore residents, enabling banks to offer enhanced hedging opportunities to their customers. Forex traders who have exposure to currencies covered by NDFs can use NDF contracts as part of their hedging strategies. For instance, in case of currency depreciation, a trader can use NDFs to hedge against potential losses in their forex positions.

How to calculate forex pips?

Calculating forex pips can be done with basic math skills. Since a pip signifies the smallest price move — typically representing 1/100th of a percentage point or 0.0001 in most currency pairs — a price movement from 1.1000 to 1.1001 signifies a movement of one pip. It’s essential to keep in mind that certain currencies have different pip definitions. The Japanese yen defines its price movements by 0.01 instead of 0.0001, so a pip for any currency pair that involves the JPY usually means a price movement by 0.01.

It’s also important to understand your position size or lot size — the quantity or volume of a currency pair that you plan to buy or sell in a single trade — as they also affect the pip value. The pip value changes according to standard lots (100,000 units of the base currency), mini lots (10,000 units), and micro lots (1,000 units).

Once you have your necessary values, you can calculate the pip value manually using the following formula: Pip value = (pip size / exchange rate) x position size.

For example, if you’re trading EUR/USD with a position size of 10,000 units, and the price movement is 0.0001, and the current exchange rate is 1.1000, your pip value would be (10,000 / 0.0001) x 1.1000 = 100,000 x 1.1000 = 110,000 USD. In this example, each pip is worth 11 USD.

Of course, this method is understandably time-consuming and may seem too complicated for trying to analyse trades on the go. The method also only works for standard and straightforward currency pairs and may take on more complex forms depending on different lot sizes, exotic currency pairs, or pairs with different pip definitions — such as the Japanese yen.

Fortunately, many online trading apps from reliable brokers today offer built-in pip calculators that provide automated pip calculations. This is a heavily recommended method for calculating forex pips as they offer better accuracy and efficiency, especially because short-term forex trading relies on fast-paced decision-making. Today, you can easily find free and paid pip calculator options on the Internet to improve your risk management and trade more effectively.

Still, it’s important to take the time to understand this tool. When using an automated forex pip calculator, you’ll have to input the currency pair you’re trading, your preferred lot size, and your account currency. Afterwards, the calculator will do all the math for you instantly so you can assess your trading strategy before or during trades.

Aside from pip calculators, some trading apps and platforms may also offer other forex calculators to help optimise your trading strategy. This includes a position size calculator to help traders determine the appropriate position size based on different inputs, a margin calculator, a profit and loss calculator, and a Fibonacci calculator that identifies potential support and resistance levels for traders who require deeper technical analysis for decision-making.

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