Forex Market and the Currency Pairs
Forex trading is always in currency pairs. For example, EUR/ USD is a currency pair where the base currency is the EUR or Euro, and the second and quote currency is the USD or the US Dollar. If you plan to buy one, then you need to sell the other. Let us assume that you want to buy 1,000 currency units when EUR/USD is $1.2. Since USD is the quote currency, then you have to pay (1.2 x 1,000)=$1,200 to buy a total of 1,000 Euros.
Understanding a pip
A pip, also known as “percentage on point” and “price interest point” for some, is a minimal price movement that an exchange rate creates. Usually, currencies are rounded off to the fourth decimal place, and that fourth decimal place is the pip — the smallest unit of measure and the last digit in a currency pair. If the currency is rounded off to the fifth decimal place, that fifth decimal place is called the pipette. In a percent, a pip is 1/100. Assuming that the amount is 0.12345, the number 4 is the pip, and the number 5 is the pipette. If there is a quote currency at $0.1234 that changed later in the trading day to $0.1238, it is a change of 4 pips.
The big four
In the forex market, the currency pairs that traders usually use are the major currency pairs: EUR/USD, GBP/USD, USD/JPY, and USD/CHF. These symbols translate as EUR or Euro, USD as the US Dollar, JPY as Japanese Yen, GBP as British Pound sterling, and CHF as Swiss Francs. We mentioned earlier that a pip’s value is the fourth decimal place. But this is only usually for currency pairs in the US Dollar denomination. In a Japanese yen-denominated currency pair, the decimal place is the second digit succeeding the decimal point.
A currency pair’s value is determined when one pip in a decimal form is divided by the exchange rate. The result in that equation or quotient is multiplied by the trade’s notional amount.
How can an individual make a profit from a pip?
A trader can profit from a pip depending on the currency pair’s movement. For example, Korina buys a EUR/ USD currency pair. She buys the Euros at $1.1111 and exits the trade at $1.1122. Korina goes home with a profit of 11 pips. She made profits because the Euro’s value increased later in the day compared to the USD. ($1.1122-$1.1111= $0.11)
On the other hand, a trader can also incur losses because of a currency pair’s movement. Assuming that Korina also bought Swiss Francs when she sold USD/ CHF at $1.2222 and the trade closed at $1.2220. Korina loses at total of 2 pips. Let us say that the trade’s closing is $1.2226; then she goes home with a four-pip profit.
These figures might look very minimal, but they might make or break Korina’s portfolio when incurred and accumulated. For example, f Korina uses a million-dollar position, she goes home with a massive profit if odds favored her speculation and anticipation. If not, she leaves with an enormous loss.