The PIP

In equities or futures, the smallest unit of measurement is called "tick" or "point". In Forex this unit is called a "pip" (for Percentage In Point). As shown in the most trading platforms a pip is the 4th decimal place after the comma or, which is the same, the ten-thousandths place in the quoted exchange rate (0.0001).

A well known exception is any currency pair that contains the Japanese Yen where a pip is the 2nd decimal after the comma (0.01). The same happens with the Thai baht.

The reason to establish a common incremental unit in Forex is due to the fact that differently to equities which are all quoted in the same currency, in Forex each currency can be quoted in any other currency. That makes sense, doesn't it?

If the exchange rate of a currency pair moves from 1.3000 to 1.3010, we say that the price moved up 10 pips. The pip incremental is what shows if a position is winning or losing. So you make money when the pips move in your favor in a trade.

An increment of a single pip has a certain value and in the case of direct-quote pairs (pairs quoted in US Dollars) that value is 10 US Dollar per standard lot, and 1 US Dollar per mini lot. Other currency pairs, like reverse quote pairs (with the USD being the base currency), and cross rates (pairs without the USD) will have different pip values.

1. Currency Pairs With Direct Quote (EURUSD, GBPUSD)

For currency pairs with direct quote the pip value is constant and doesn't depend on the current exchange rate of the pair being traded.
pip value = (lot size) X (pip size, with the corresponding decimal location / exchange rate)

where the exchange rate is always the ask price.

Here is an example with the EUR/USD with the quote being 1.2599/1.2600.

€ 100,000 X (0.0001 / 1.2600) = € 7.93 = 1 pip

However, to get the value of the trade in Dollars, then multiply € 12.6 by the current EURUSD quote:

€ 7.93 X 1.2600 = $ 9.99 ($ 10.00 rounded up)

This phenomenon is observed when the Dollar is the counterpart or quote member within the pair: the pip value is always the same.

In the above example, a EUR/USD standard lot represents 100,000 Euro which can buy 126,000 US Dollars at the exchange rate of 1.2600. Therefore, the EUR/USD currency pair could be expressed as 100,000 EUR / 126,000 USD.

If you buy the EUR/USD and it moved up by one pip to 1.2601 you have earned $10. You can see the difference by substracting the pair as 100,000 EUR/126,010 USD. The amount of USD has grown on the right side of that equation by $10- the value of the pip.

2. Reverse Quote Pairs (USDJPY, USDCHF)

For those pairs having the USD as the base currency the pip value measured in Dollars is calculated with the same formula as with direct quote pairs:

pip value = (lot size) X (pip size / exchange rate)

However, in reverse quote pairs the pip value in US Dollars changes depending on the current quote.

For example, exchanging a standard lot with the pair USD/JPY at the rate 107.00, the pip would be worth:

$ 100,000 X (0.01/107.00) = $ 9.346 = 1 pip

In these cases you don't need to exchange the pip value to US Dollars in order to get the face value of the trade, because the lot size is always in the base currency and so is the pip value.

3. Cross-Rates (GBPCHF, EURJPY etc.)

The pip value measured in Dollars in cross currency pairs is a little trickier.

For example: with the EUR/NZD rate representing 1 / 2.5040, or expressed in a standard lot, 100,000 EUR / 250,400 NZD at the current exchange rate, if the pair moves up one pip to 2.5041 then the position would have incremented 5,03 US Dollars per pip.

Too abstract? Alright, this is the formula:

pip value = (lot size) X (pip size) X (base exchange rate / exchange rate)

where the base exchange rate is the current quote of the base currency against US Dollar, and the exchange rate is, like in the previous formulas, the current quote of the traded pair. Therefore:

€ 100,000 X 0.0001 X (1.2600 / 2.5040) = $ 5.03 = 1 pip

For cross-rates the pip value is changing depending on the current exchange of the traded pair AND the base currency exchange rate to the US Dollar. Got it? Great!

The formula seems complicated because we are converting it to US Dollars. But if your account is in EUR and the traded pair is the EUR/NZD, then you don't need to input the base exchange rate in the calculation. Supposing you buy a standard lot of EUR/NZD, the value of the pip is:

€ 100,000 X (0.0001/2.5040)= € 3.99 = 1 pip