How to Understand FOREX Pips
A FOREX (foreign exchange) rate is a numerical quote representing the bid (buying) and offer (selling) rate of a currency pair. Each currency pair is an individual trading product and is traditionaly quoted according to ISO 4217 international three letter code. For example, the sterling dollar exchange rate is quoted as GBP/USD followed by the numerical exchange rate 1.2256. The actual exchange rate is made up of two components: the big figure (the number before the decimal point) and the basis points or pips (the numbers after the decimal point).
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Instructions
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Foreign Exchange Pips
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1
The GBP/USD exchange rate is the 4th most traded currency pair. Take the sterling dollar exchange rate GBP/USD 1.3035-1.3037. The rate is quoted to four decimal places with the final decimal place being 1/100th of 1 percent. The smallest change to a rate is one pip or one basis point. The only exception to this rule is Japanese Yen which is quoted to only 2 decimal places (USD/JPY 98.40).
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2
Calculate what a one pip change in the GBP/USD rate of 1.3050 would be in dollars if you bought GBP 1,000,000. As a pip is 1/100th of 1 percent and there are 1.3050 dollars to every one sterling pound, a one pip change is 1,000,00x0.0001=100 dollars.
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3
Calculate the value of the loss or gain in dollars if the GBP/USD rate moved to 1.3055. In step 2 the GBP/USD rate was 1.3050 dollars for every pound. Now there are 1.3055 dollars for every pound. More dollar pips per pound means the pound has appreciated in value against the dollar. So 1,000,000x0.0001x5=500 dollars. If you sold GBP1,000,000 you would receive 500 dollars more than you sold to buy sterling.
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4
The EUR/USD exchange rate is the most traded currency pair. Imagine that the market rate for EUR/USD was 1.2234-37 (the offer side of a rate is always quoted as the last two pips, 1.2237). You would buy Euro at the offer rate (1.2237) and sell Euro at the bid rate (1.2234). If you wanted to buy EUR 1,000,000 you would buy using the offer rate of 1.2237. The difference between the bid rate and offer rate is 3 pips or 300 dollars. (1,000,000x0.0001x3=300 dollars).
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5
Buy 1 million Euro at 1.2237. You now have to wait for the markets bid rate which is at 1.2234 to move above 1.2237 to make a profit. The market has to move at least 4 pips for you to make a 100 dollar profit on the deal. (1,000,000x0.0001x4=400 dollars).
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Think about the consequences if the EUR/USD rate drops by only one pip to 1.2233-36, you are already 4 pips in the red at 400 dollars because you would have to sell at 1.2233 which is 4 pips lower than the rate you bought at.
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Watch how pips move because the movement gives buyers or sellers a small indication in which direction a currency pair is going. You see GBP/USD at 1.3540-43 and then it moves to 1.3540-42. This could mean that GBP will appreciate as the bid and offer have narrowed to 2 pips so more buyers would come into the market and buy sterling at the cheaper rate of 1.3542. If however the rate widened to 1.3538-43 (5 pips), this could indicate that more people are selling sterling at 1.3538 and that sterling will depreciate.
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- Photo Credit Karieskiller image by Kica Henk from Fotolia.com pound image by Roques Jean Chris from Fotolia.com Euro image by DeVIce from Fotolia.com
