The acronym PIP or rather pip which stands for percentage in point refers to the smallest measure for price movements in the Forex market. Since currency prices in Forex market are quoted in fractions, pip is the smallest decimal place that you could find in the price quotes.
We can generally divide currency pairs two groups. The first group do not include Japanese Yen. This group contains 4 decimal places. For example if the price Eure versus US Dollar is quoted 1.4523 and the price moves to 1.4524 then price has changed by 1 pip. The easy way to make calculations is to ignore the whole number and deduct the decimal sections (i.e. 4524-4523=1pip).
The second group consists of Yen as part of the quote for example US Dollar versus Japanese Yen versus. In this group the number of decimal places is limited to 2. For example if the price of USD/JPY changes from 117.12 to 117.13 then the price has risen by 1 pip. I suggest to make calculations by ignoring the decimal place (i.e. 11713-11712=1 pip).
What is the Dollar Value of a Pip?
The pip by itself has not a dollar value. That is probably one of the reasons that we use it to evaluate a trading system. It independent of your investment amount shows how good or bad your system is trading. Why it does not have a Dollar value? Because it actually represents a ratio rather than an amount. For example when we quote GBP/USD to be 2.1230 it means that every Great British Pound is equivalent to 2.1230 US Dollars at the moment. As you can see the ratio does not refer to a specific currency pair but compares two currency pairs together.
However, at the end of the day you need to see how much money you have made or lost. Therefore it is important to extract a meaningful value from pip numbers.
To make this happen I need to explain a few basic Forex concepts and definitions. Here for the sake of the argument I assume that your account currency of denomination is United State Dollar. You can easily expand the definitions to other types of accounts (for example if your account with your broker is in Euro or Australian Dollar or any other currency).
Base Currency: In a currency pair the base currency refers to the first one. For example in EUR/USD the base currency is EUR.
Quote Currency: In a currency pair the quote currency refers tot he second one. For example in EUR/USD the quote currency is USD.
Cross Currncy: It refers to a pair that none of the currency pairs are US Dollar. For example GBP/JPY is a cross currncy.
Trading in the Long Direction: This concept refers to buying the base currency in exchange of the quote currency. For example when you go long on EUR/USD you are purchasing EUR in exchange of USD.
Trading in the Short Direction: It refers to selling the base currency in exchange of the quote currency. For example if you go short on EUR/USD then you are selling EUR in exchange of USD. In Forex you can easily trade in both long and short directions.
Lot: This word refers to the size of your forex contract. A standard lot refers to 100,000 units of the base currency. For example if you trade 1 lot of EUR/USD then you are either buying or selling 100,000 Euro in exchange of US Dollar. These days many brokers support fractions of a standard lot. The most popular fractions are mini lots or rather 10,000 units and micro lots or rather 1,000 units. For example if you trade 1 mini lot of USD/JPY then you are trading 10,000 USD in exchange of Japanese Yen.
Now that we know some basics we can calculate the dollar value of pip through 3 examples. In all the following examples I assume that we are trading 1 standard lot of the currency pair. I also consider profitable trades that generate 1 pip in profit.
Example 1: Going Long on NZD/USD
This is the easiest way to calculate pip value in Dollar. You can generalize this example to any USD pair that USD is the quote currency.
Let's assume that we buy NZD/USD at 0.6856 (which means we go long) and then we close the trade when the price has reached 0.6857. As you can see this trade generates 1 pip in profit (i.e. 6857-6856=1). When you purchase a standard lot of NZDUSD it means that you need to purchase 100000 NZDUSD. Since the price at the time of purchase has been 0.6856 you have actually paid 68560 USD for this contract (i.e. 100,000x0.6856). When you close the contract you gain 68570 USD (i.e. 100,000x0.6857). This means that your overal profit would be $10.00.
We can generalize this calculation for any currency pair that the quote currency is USD. Every pip in such trades is equivalent to...
$10 x Number of Lots
So if you trade 3 lots and you make 1 pip then your realized profit would be $30.00 (i.e. $10x3). If you trade 1 mini lot then your profit woudl be $1.00 (i.e. $10x0.1). If you trade 5 micro lots then your profit would be $0.05 or rather 5 cents (i.e. $10x0.05).
You may expand this forumla as follows:
Profit in USD=10 x Number of Lots x Number of pips gained or lost
I need to emphasize that this formula is only valid for those currency pairs that USD is the quote currency and also the account currency of denomination is USD. You may use the same concept for short trades. The only difference is that you make money in a short trade if the price drops.
Example 2: Going Short on USD/JPY
We may expand this example to all those pairs that USD is their base currency (for example to USD/CAD or USD/CHF). The calculations are a bit more complicated in this case.
Let's assume that you sell USD/JPY at 105.81 and then close the trade at 105.80. Here you have made 1 pips in profit (i.e. 10581-10580=1). Since this is a short trade we made money when the price dropped below the open price.
At first we sold 100,000 USD in exchange of JPY. Since the price was 105.81 we then gained 10,581,000 Japanese Yen (i.e. 100,000x105.81). At the time that we close the trade the priced had dropped to 105.80 so this simply means are Yen was then worth 100,009.45 USD (i.e. 10,581,000/105.80). This means the we sold 100,000 USD but we gained 100,009.45. This means that our profit in this trade is $9.45. As you can see here 1 pip is less than $10 (for a standard lot) and depends on the price at the time of entering and closing the trade. Here we can say that 1 pip in terms of Dollar can be calculated from the following forumla:
Number of Lots x Lot Units x (Price Difference/Close Price)
In the above example 1 pip was 1 x 100,000 x [(105.81-105.80)/105.80) = 100,000 x (0.01/105.80) = $9.45
All this means that pip dollar value in such pairs depends on the currency price and can vary from time to time. If we decide to come up with a formula for profit or loss we can use the following for those pairs that their base currency is USD.
Profit/Loss in USD = Number of Lots x Lot Units x (Price Difference/Close Price) x Pips gained or lost
Example 3: Going Long on GBP/CHF
You may have noticed from the previous two examples that the calculations of profit/loss depends on the quote currency rather than the base currency. The same concept applies for cross currencies. For example when you trade GBP/CHF the profit/loss is caclculated based on the movements on CHF (Swiss Franc). Since the account currency of denomination is USD you need to consider the price movements of USD/CHF at the time of entry and exit in order to be able to make the calculations. In other words the formula for the cross currencies would be as follows.
P/L in USD=Number of Lots x Lot Units x (Price Difference of quote currency vs. USD/Price of quote currency vs. USD at the time of the close) x Pips gained or lost
This make things a lot more complex as you need to know the exact price of USD/CHF when you enter and exit your GBP/CHF trades.
You may then ask yourself what is the point to trade cross currencies. There could be different reasons to do that. For example your strategy may fit a cross currency much better comparing to a USD paired currency. You also need to know that margin calculations are based on the base currency of a cross currency. For example when you trade GBP/CHF the amount of margin that you consume is equivalent of trading GBP/USD. So as you can see both pairs affect your account. The base affects your margin consumption and the quote affects your Profit/Loss.
What is Fractional Pip?
Some brokers offer pip fractions or rather an extra decimal place in their prices. These brokers show the price of non-Yen pairs as d.ddddd instead of d.dddd (for example 1.32451 instead of 1.3245) and Yen pairs as ddd.ddd instead of ddd.dd (for example 106.258 instead of 106.26). We call the last decimal place in such pricing a pip fraction or tenth pip.
Pip Calculations in MQL Programming
There is a reserved word Point in MQL (MetaQuotes Language) that represent a pip. You need to use this variable as its exact value depends on whether you trade a Yen pair or a non-Yen pair.
Dealing with pip fractions is a little bit more complex. I have developed two documented Expert Advisors that address this issue. You may download them from the download section. They are called Double_Pending.mq4 and Short_Trade.mq4. You need to be a member of ForexBrace.com in order to be able to have access to the download section. To become a member click here.
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