A PIP (or “price interest point”) is a unit of measurement used in forex trading to indicate the change in value between two currencies. It is usually expressed as a percentage or fraction and helps traders determine their profit or loss on a trade. For example, if one currency is bought for 1.2500 US dollars and sold for 1.2550 US dollars, the trader has made 50 pips (1.2500 – 1.2550 = 0.0050). In this case, the trader would earn 50 pips from the transaction.
How to calculate a PIP
When trading with PIPs, you must know how to calculate them to ensure accurate pricing. It will help you determine the value of a currency pair and how much gain or loss you can make on any trade.
Understand the currency pair
To calculate the PIPS for a given currency pair, you must first understand the base and quote currencies in that pair. The base currency is always listed first (ex: USD/JPY) and is used as the reference point for determining the PIP value. The quote currency follows after (ex: JPY) and is used to determine the exchange rate between two currencies.
Once you understand which currencies are involved in a pair, calculating pips becomes relatively simple. To do this, divide the difference between the two prices by the “pip value”. The pip value changes depending on which pair is traded, so it’s essential to check your broker’s website for the specific values they offer. For example, if you are trading USD/JPY and the price moves from 105.50 to 105.51, this would be a one-pip move (105.50 – 105.51 = 0.01 ÷ pip value of .00001 = 100 pips).
Calculate your gains or loss
Once you have determined the number of PIPS for a given trade, you can use that information to calculate your potential gains or loss. To do this, multiply your position size by the number of PIPs you have earned or lost. For example, if you purchased 1,000 units of a currency pair at 105.50 and sold them for 105.51, you would have made 100 pips in profit (1,000 x 0.0001 = 100).
Risk management is an essential part of trading forex and should be considered when calculating PIPs. Before entering any trade, it’s vital to ensure that your risk-reward ratio is favourable enough to make the trade worthwhile. You must set a stop-loss order that automatically closes out your position if the market moves against you beyond a certain point for this. If you are struggling with this step, you can consult a Saxo forex broker to help with your risk management strategy.
How to use PIPs in forex trading
Now that you know how to calculate a PIP, you must also know how to use PIPs in forex trading. This process is not as complicated as it may seem and involves understanding the basic concepts of currency trading.
Understand the basics
Before using PIPs in trading, you must understand the fundamentals of forex trading. It includes knowing the major and minor currency pairs, understanding how different economic indicators impact exchange rates and learning how to read a chart. All these factors will help determine the direction of any given currency pair and help you make better decisions when trading.
Choose your timeframe
Once you understand the basics, it is time to choose a timeframe for your trades. The length of time you choose will depend on your risk tolerance. Shorter-term trades carry more risk but offer more potential rewards, while longer-term trades are less volatile but may take longer to provide profits. Consider short-term day trades and long-term swing trades when deciding the suitable timeframe for your trading strategy.
Set up orders
Once you have chosen a timeframe, it’s time to set up your orders. When using PIPs in forex trading, you should always use limit orders rather than market orders to ensure better pricing. Limit orders will allow you to enter and exit a trade at its most favourable price. Additionally, set stop-loss and take-profit points before entering any trade to protect yourself from potential losses.
Monitor the market
It is essential to monitor the markets constantly to react if needed. Use charts and technical analysis tools such as indicators and oscillators to identify the best trading opportunities. Keep an eye on the news, and economic data releases, as these can significantly affect exchange rates.