WHAT ARE PIPS?
How Important are FX Pips ? Lets start with the meaning First off, “PIPS” stands for Point In Percentage in the Forex World. In all pairs involving the Japanese Yen (JPY), a PIP is the 1/100th place – 3rs places to the right of the decimal. In all other currency pairs, a pip is the 1/10,000th place – 4 places to the right of the decimal.
THE COMMON MISUNDERSTANDING OF PIPS
Let me give you a simple example to make sure we’re all on the same page: If you bought the EUR/USD at 1.0000, then closed your trade in profit at a price of 1.0011 you’ve made a gain of 11 pips in forex trading. In most cases – and honestly speaking its put – this is very misleading as most novice traders incorrectly perceive this as a fair measurement of one’s proficiency.
A PIP is merely a fractional change in price and has no direct relationship to the given trade unless we consider a few factors first.
PIPS are only important once you determine what value the average PIP was relative to the trade at hand and strategy independently adopted.
WHAT IS THE PIP VALUE – HOW DO WE FIGURE THIS OUT?
That’s to say, placing a usual sized trade with your broker, how much (monetary) is one PIP move in the exchange price on the pair in question?
This is the basic formula to work out what each PIP is worth in the “Term Currency”(i.e. not the traders denominated trading currency):
( PIP / Exchange Price ) x Lot Size (Units) = Value Per PIP
So placing a 0.10 (10,000 units) on the price we just looked at on GBP|USD looks like this:
( 0.0001 / 1.71250 ) x 10,000 = $0.71 (term currency – not denominated trading currency)
Pretty simple stuff! Let’s look at some hypothetical traders so that we can put this into practice and see whether PIPS is really a standardized way in determining a traders profitability…
HYPOTHETICAL FX TRADERS
She uses hard stops of 30 PIPS but sometimes intervenes to cut her losses sooner.
Today Jasons closed trades look like this:
GBPUSD – Buy: +33 PIPS
GBPUSD – Sell: +17 PIPS
GBPUSD – Sell: -30 PIPS
Jasons Total PIPS: -14 PIPS
As we know already, Jasons uses fixed lots. Now we can see what her trades looked like in her denominated trading currency:
EURUSD – Buy: +23 PIPS x £0.61 = +£14.03 Profit
EURUSD – Sell: -17 PIPS x £0.61 = -£10.37 Loss
EURUSD – Sell: -20 PIPS x £0.61 = -£12.20 Profit
Jasons Total Loss: -£8.54 or -0.85% on her initial £1,000 GBP trading balance.
Therefore, we now know that when Sally tells us how many PIPS she has made, this does in-fact equate into a fair means of evaluating her profitability as each PIP is worth the same under the given circumstances.
He also has rules to only trade if there is a 1:1 risk:reward ratio as a minimum.
Today James’ closed trades look like this:
EURGBP – Buy: +65 PIPS
GBPUSD – Sell: +40 PIPS
AUDJPY – Sell: -190 PIPS
Connor Total PIPS: -80 PIPS
Connor finished the day down on FX PIPS. Just before he placed the 3 trades, he did the following calculations first:
Current Trade Balance: $5,000 USD * 1.5%(risk) = $75.00 USD (risk)
Trade 1 EURGBP: Connor strategically wants to place the stop loss 45 PIPS away from his entry price. He then does the following calculations to figure out what lot size he should be using to entertain his risk profile of 1.5%:
45 PIPS / $75 = $1.66 per PIP
What is PIP value per 1,000 units (0.01) on EURGBP? = ( 0.0001 / EURGBP 0.79040 ) x 1,000 = €0.12(term currency)
He then wants to know what each PIP is worth in his own trading currency: €0.12 x EURUSD (1.27400) = $0.16
Revisit point 1 above^, take $1.66 and divide by $0.16 = 10.3 – rounded down is 10 = 10,000 units or 0.10 lots.
Therefore, Connor traded the EURGBP with a 0.10 lot size. He made on the trade +45 PIPS, which is a monetary gain of: +$72(rounded in deposit currency)
Using the following principles above, each trade Connor places has the same monetary risk, relative to the closing balance.