Traders use pips in various calculations throughout their trading process. They commonly use pips when they want to calculate their spread cost, the amount of money needed to buy/ sell an asset, their potential earnings, or unwanted losses. In saying that, a pip is the most basic unit of measure in trading. For every trader it is important to know, not only what is a pip, but how to calculate its value and how it relates to a certain asset.  
 

What is a Pip and how to calculate it?

A pip stands for “price interest point” and we can find it in every change of the value of a currency pair or any other asset. 

Movement in the exchange rate is measured by pips.

For example, when traders look at a certain currency pair, they’ll see two prices (sometimes only one) expressed in decimal numbers. These two prices contain one pip each. The 4^th decimal place of the price shown is called a pip, with an exception of the Japanese Yen, where all currency pairs that include JPY have a pip on the 2^nd decimal place. From this, we can conclude that a single pip change is equivalent to 0.0001 (except JPY currency pairs).

Since the prices are always changing, the pip is changing, too. Therefore, we can also say that a pip is a measure of the price change. 

If the price for a currency pair GBP/USD moves from 1.3332to 1.3333, we say that the price has increased by one pip. 

When it comes to calculations, the pip is equivalent to 1/100^th of 1%. Visually, we can represent it like this:

What is a Pipette?

Now that we’ve introduced the pip, we can move on to the pipette.

A pipette, or a fractional pip, is a tenth of a pip and so it’s the 5^th decimal place. (But, where a pip is the 5^th decimal place, a pipette is the 6^th decimal place)

What is a Pip value?

Another term we need to explain is a pip value. A pip value is a price attributed to a one pip change. 

Factors that affect the pip value are: the currency pair traded, the size of the trade (lot size) and the exchange rate of the currency pair. To explain the calculation of a pip value, we will use an example. 

For instance, you want to trade on the foreign exchange market with the USD/CHF currency pair. For the USD/CHF, the prices are as follows: 0.9101(the bid price) and 0.9104(the ask price).

Let’s say that you want to open a position with the standard contract size of 100,000 units (equal to 1 lot). The formula for pip value goes like this: 

Pip value = (Size of a pip / Exchange rate) x Contract size
 

• Here, the difference between the bid and the ask price is in 3 pips or 0.0003 pip size (0.9101 and 0.9104).
• The exchange rate is expressed through the buying price (or ask price) and it’s 0.9104.
• The contract size is 100,000.

With these data, our final calculation is:
Pip value = (0.0003 / 0.9104) x 100,000 = 32.95

This means that you bought 100,000 USD against CHF at the buying price of 0.9104 and you earned $32.95 for every pip increase in your favor. 

Note: If a currency pair you want to trade is EUR/USD, the pip is 1 and the contract size is standard (100,000 units), in this case, the pip value will always be $10. 

This also applies to every other currency pair where USD is the counter currency, such as: GBP/USD, AUD/USD and NZD/USD. 

To conclude, when USD is a second currency and we’re trading:

• a standard lot (100,000 units), pip value is $10;
• a mini lot (10,000 units), pip value is $1;
• a micro lot (1,000 units), pip value is $0.1;
• a nano lot (100 units), pip value is $0.01.

Conclusion

Traders must understand the definition of a pip even before they open their first position. A pip is a basic unit of measurement commonly used in forex trading and other online financial markets. A pip is the last decimal place of the price quote, which is usually the 4^th decimal place. 

A pipette is smaller than a pip and comes on its right side, which is the 5^th decimal place. 

For calculations, traders use a pip value which is a price connected to a one pip change. To find out a pip value, we use a specific formula that contains three elements: the size of a pip, exchange rate (express through the buying price) and contract size.

 

Sources Consulted:
1. Lee, M. What is a pip? https://www.investopedia.com/ask/answers/06/pipexplained.asp (2020)
2. Chen, J. Pip Definition. https://www.investopedia.com/terms/p/pip.asp (2021)
3. What is a pip in forex? https://www.babypips.com/learn/forex/pips-and-pipettes (2011)