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What is a "pip"?
A pip is a standardised unit and is the smallest amount by which a currency quote can change. It is usually 0.0001 for U.S.-dollar related currency pairs, and 0.01 for Japanese yen related currency pairs since they go out to two decimal places.
For example, if the exchange rate of EUR/USD rise from 1.1343 to 1.1345, that 0.0002 rise in the value equals to two pips.
On the other hand, since the Japanese yen pairs go out to two decimal places, the second decimal 0.01 is considered a pip.
For example, if the USD/JPY exchange rate rise from 109.74 to 110.74, then it is said that USD/JPY has climbed by 100 pips.
To illustrate it better, let’s assume that we have a USD/CAD quote of 1.3262. As it was discussed before, what this quote tells us is that for 1 US dollar, you can receive about 1.3262 Canadian dollars. If there was a ten-pip increase in this quote (to 1.3272), the value of the U.S. dollar would rise relative to the Canadian dollar, as now 1 US dollar would allow you to receive slightly more Canadian dollar, which in this example would be equal to 1.3272 or to put it differently, now one Canadian dollar would give you less US dollar (1/1.3272=0.7534 USD).
USD/CAD = 1.3262
- 1 USD = 1.3262 CAD
- 1 CAD = 0.7540 USD (Simply flip USD/CAD to CAD/USD by dividing 1 over 1.3262)
USD/CAD= 1.3272 (+10 pips)
- 1 USD = 1.3272 CAD
- 1 CAD = 0.7534 USD
The effect that a ten-pip change has on the amount of base currency purchased, or of the pip value itself, depends on the units of base currency purchased.
For example, if a trader buys one standard lot (100,000 units) of US dollar with Canadian dollar or similarly, buy one lot of USD/CAD, the price paid will be 132,620 Canadian dollar ([1.3262] x 100,000) assuming the exchange rate for USD/CAD is 1.3262.
If the exchange rate for this pair experiences a ten-pip increase, and then the trader decides to conduct the same transaction the price paid now would be 132,720 Canadian dollar ([1.3272] x 100,000) for the same one lot purchase of US dollar.
In this case, due to a ten-pip rise in the exchange rate of USD/CAD you have to pay 100 Canadian dollar (132,720-132,620) more to receive the same one lot of the US dollar.
The pip value on a one-lot purchase of USD/CAD will be Can$ 10 per pip (100/10), which equals to US$ 7.53 per pip.
Therefore, if the trader executed a one-lot buy earlier before the ten pip rise in the exchange rate he would have saved 100 Canadian dollars. However, if he decided to execute a one-lot buy after the ten-pip rise he would have paid 100 Canadian dollars more for receiving the same one lot US dollar.
Now if we assume the trader decides to sell a one-lot USD/CAD, it means that he/she is selling one lot of US dollar and receiving Canadian dollar. Therefore, assuming the exchange rate remains the same as the example above, 132,620 Canadian dollar will be received for the sell of one lot or 100,000 US dollar.
However, if the same scenario happens and the exchange rate jumps by a ten-pip, then the trader decides to sell USD/CAD, he will receive 132,720 Canadian dollar for a one-lot US dollar.
Now if the trader purchases or sells a mini lot (10,000) instead of a full lot of US dollar, a pip value would have been Cad$ 1 or US$ 0.75 for a mini lot transaction.
Therefore, the pip value increases depending on the amount of the underlying currency (in this case US dollar) purchased.
Read the next chapter, for more details on pip value calculation for each currency pairs and more examples on pip value calculation.
A pip is a unit of measurement for currency movement and is the fourth decimal place in most currency pairs.
For the Japanese yen related pairs a pip is considered the second decimal place.
The pip value depends on the amount of underlying currency that is purchased.