PIP

Definition

A pip (short for "percentage in point" or "price interest point") is the smallest standardized unit of price movement in the foreign exchange (forex) market. It represents a fixed measurement of change in an exchange rate, typically 0.0001 for most currency pairs (one basis point) and 0.01 for pairs involving the Japanese yen.

Pips are used to quantify gains, losses, and spreads in forex trading.

Origins

The term "pip" likely originated from the phrase "percentage in point", reflecting its function as a precise, fractional measure of price change. It became widely adopted in the 1970s and 1980s with the rise of computerized forex trading platforms that required standardized pricing increments.

Usage

Pip are used in:

• Forex trading – Calculating profits, losses, and spreads.

• Derivatives – Measuring tick size in currency futures.

• Risk management – Defining stop-loss and take-profit orders.

• Technical analysis – Measuring volatility and price patterns.

How a Pip Works

1. Identify the currency pair – Most pairs have four decimal places; yen pairs have two.

2. Determine pip value – For EUR/USD, a move from 1.1000 to 1.1001 is 1 pip.

3. Calculate pip worth in money – Depends on lot size and currency.

4. Apply in trade P/L – Multiply pips gained/lost by pip value to find profit or loss.

    

Types & Variations

1. Standard Pip

• 0.0001 change in a non-JPY currency pair.

2. JPY Pip

• 0.01 change for yen-based currency pairs (e.g., USD/JPY).

3. Pipette

• 0.00001 or 0.001 (1/10 of a pip), used for more precise pricing.

   

Key Takeaway

• Standard pip size: 0.0001 for most pairs, 0.01 for JPY pairs.

• Pip values vary depending on lot size and currency exchange rates.

• In high-frequency trading, fractional pips (pipettes) are used (1/10 of a pip).

• Essential for forex risk management and trade execution.

Context in Financial Modeling

Pips matter for:

• Profit and Loss modeling in forex portfolios.

• Value at Risk (VaR) – Measuring volatility in pip terms.

• Trade backtesting – Assessing historical performance in pips gained/lost
  
  

Nuances & Complexities

• Broker differences – Some use fractional pip pricing.

• Leverage effects – Small pip moves can result in large percentage gains/losses.

• Currency volatility – Pips may represent different real-world values depending on market conditions.
  
  

Mathematical Formulas

Pip Value for Standard Lots (100,000 units):

$$\text{Pip Value} = \frac{\text{One Pip in Decimal Form} \times \text{Lot Size}}{\text{Exchange Rate}}$$

Example – EUR/USD at 1.2000:

$$\text{Pip Value} = \frac{0.0001 \times 100,000}{1.2000} \approx 8.33 \ \text{EUR}$$

$$\text{Overcollateralization Ratio} = \frac{\text{Collateral Value} - \text{Bond Value}}{\text{Bond Value}}$$

Related Terms

• Tick Size
  
  

• Spread
  
  

• Lot Size
  
  

• Pipette
  
  

• Basis Point (bps)
  
  

• Forex Margin

Real-World Applications

Example 1: EUR/USD Trade

• Entry: 1.1050

• Exit: 1.1100

• Change = 50 pips; with a $10 pip value (standard lot) → $500 profit.

Example 2: USD/JPY Trade

• Entry: 110.25

• Exit: 110.75

• Change = 50 pips; at ~$9.09 per pip → $454.50 profit (standard lot).

Example 3: Pipettes

A broker quotes EUR/USD as 1.10508 → 1.10518. The change = 1 pip (10 pipettes).

References & Sources

• Accounting Insights: What Does Pips Mean and How Are They Calculated?