Friday, September 28, 2007

Pip in Forex Trading The Final Hit

In general terminology the abbreviation pip may refer to many things like Protective Industrial Products, Picture-in-Picture, Personal Identity Provider, Partners in Protection, Preferred Internet Provider, Performance Index Paper etc.

In currency trading pip stands for percentage in point. This is the smallest increment of change in forex trade. It is the smallest number in quotation of a currency.

In foreign exchange market, rates are quoted to the fourth decimal point. For example, if the price of a burger in the market is $1.22, in forex market the same burger will be quoted as 1.2200. Under this example, the 4th decimal point will constitute one pip and normally equals 1/100th of 1%.

The above is the general rule. Exception to this is the quotation in USD/JPY which is only up to 2 decimal points. This is because Japanese Yen has not been revalued since Second World War. Thus in case of Yen, the quotation is only up to 1/100th of yen as against 1/1000th with other major currencies.

All other currencies in relation to Yen will be quoted up to 2 decimal points. The usual pairs will be AUDJPY, CADJPY, CHFJPY, EURJPY, GBPJPY etc.

Other factors that go in the understanding of a pip are trading size, extent of leverage and rate of a currency pair. In case of USD, with a leverage of 1:100 and trading volume of one lot, one pip will have a value of $10.

The above will be the minimum incremental value by which USD will fluctuate. Thus, if there is a one pip change, that means one has gained or lost $10.

One pip value for one lot in USD will be equivalent to $10 in case of all currency pairs not involving JPY. Where JPY is the other currency in a pair, one point value will be equivalent to $1000 / USDJPY rate.

Closely associated with pips is the spread. This is the difference between bid price at which a forex broker is willing to buy the first currency of a pair and the offer or sell price at which he is willing to sell the first currency of a pair. The difference between bid and ask prices is the spread.

If EUR/USD is quoted as 1.4205/1.4207, the spread will be equivalent to EUR 0.0002 or 2 pips. The size of a spread depends upon the popularity of a currency pair. The more popular a pair, smaller the spread and vice versa.

Pip spread may be better for major players which trade in large quantities as compared to retail or individual traders. Spot prices on EUR/USD are usually no more than 3 pips wide (0.0003). With increased competition, pip spreads have shrunk on major pairs to as little as 1 to 2 pips.

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