The unit of measurement to present the variation in value between two instruments is called a “pip”, standing for Point in Percentage. A FX pip is a standardized unit and is the smallest amount by which an instrument quote can change in Forex trading.
In currencies, the pip is usually the 4th decimal point; however, in some exceptions, the pip can be the 2nd decimal point, for example the Japanese Yen Pairs.
Some Forex brokers tend to quote currency pairs beyond the usual of “4th and 2nd” decimal points to “5th and 3rd” decimals. Such are quoted as Fractional Pips, or “pipettes.” These pipettes allow for even tighter control on profits and losses as they offer more flexibility on spreads.
The pip reading could vary from one instrument to another. Unlike currencies, the pip in indices is considered to be the ones digit while in commodities it is the 2nd decimal point. For example, the Dow Jones is quoted as US30=24115 while Gold is quoted as XAUUSD=1238.25
How to Calculate Gains and Losses in Pips or Pipettes in Forex trading:
Let’s take the EUR/USD as an example for a Forex trade.
This could be understood as: 1 Euro is to 1.1380 USD. Hence, for 1 Euro, a Forex trader can buy 1.1380 USD; or, for 1 USD, the Forex trader can buy 0.8787 Euros (1/1.1380).
The effect that a one-pip change has on the dollar amount, or pip value, depends on the number of Forex lots of euros purchased.
Now, take a Forex trade for instance:
- A Buy order is executed when EUR/USD is 1.1380 for 0.1 lot or 10,000 EUR
- A Sell Order is executed when EUR/USD is 1.1390 for 0.1 lot or 10,000 EUR
The Profit per Pip is calculated by the difference from the Sell and Buy orders.
Then, Profit = 1.1390-1.1380= 0.001*10,000=10 pips/trade
Or, Profit = 1.1390-1.1380=0.001*100,000=100 pipette/trade