What Is A Pip In Forex Trading? How To Use It To Lower Risk!

When I searched the Internet I found out that so much has been written about the pip. And how confusing I found it. It made me wonder if there was a simpler way to explain this for beginners. Let me share with you what makes the most sense in answering the question, what is a pip in Forex trading.

Once you know what a pip is I feel it is more important to understand how to use it to set up your trades to minimize risk. The next most important thing is to learn how to make consistent gains in trading, measured in pips.

So, What Is A Pip In Forex Trading?

The formal definition is Percentage In Point (PIP). What does that mean in simple English?

 A pip is the smallest price move that an exchange rate can make based on forex market convention. Most currency pairs are priced out to four decimal places and the pip change is the last (fourth) decimal point.

All major currencies except the Japanese YEN are quoted using 4 decimal places. When the fourth decimal place moves by one step, that movement is called a PIP. Since currency pairs have a value one against the other, let me explain it this way using the EUR-USD pair.

Investopedia

Say the quoted exchange rate for the Euro Dollar is 1.3461. At the time of this quote, one Euro will get you 1.3461 US Dollars. When it changes to 1.3462, this is referred to as an increase in one pip. If it changes to 1.3460, that is a drop in one pip.

Pairs involving the Japanese Yen are quoted to two decimal places. Hence a pip is when the second decimal place moves by one step.

For example, let’s say the USD-JPY pair has an exchange rate of 114.46. When the rate changes to 114.47, this is called an increase in one pip. And when it falls to 114.45, we have here a drop in one pip.

How To Rate Pip Movements In Dollars & Cents

I can see the importance of knowing exactly what the precise value of a pip is when you are a professional and trading serious money.

When you are learning to trade as a beginner, or just want to know the basics, it is not necessary to go into all the math to figure this out exactly.

If you really want to know the nitty-gritty, you can easily get that information using a Google search.

What can we do to keep this simple? And provide greater rewards?

The first factor that influences the value of a pip is the lot size selected for the trade. Since beginners use a capital of typically $1000 – $2,000, the lot size used should never be more than 0.01 also called a micro-lot. Hence I shall use a micro-lot in the following explanation.

Pip Rate Range And Value In US Dollars

When a micro lot is used to place a trade, all pairs involving the USD, a movement of one pip is equivalent to 10 cents. For every other pair, the value of a one pip movement ranges from a high of 11 cents to a low of 7 cents.

For pairs that do not include the USD, also called cross currency pairs, this range may widen a little to say 12 cents to 6 cents.

Beginners to Forex trading, as well as more experienced traders who are still building up their capital, knowing the precise value of a pip is not critical to trading. It is much more important to learn to make trades that give you profits in pips regularly.

Let’s Keep It Simple

For the sake of simplicity and ease of calculation, why don’t we agree to approximate a one pip movement to 10 cents for any pair, for trades made using one micro lot, 0.01?

Hence, if your trade has a gain of 100 pips, this would be equivalent to $10.00. Conversely, a drop of 100 pips will be a loss of $10.

By extrapolation for trades made using a mini lot, 0.1, a one pip movement can be approximated to $1.00. And for a single lot, a pip movement would be $10.

You can make trades using multiple micros, mini and single lots. In these cases, just multiply the end gain or loss in pips accordingly to estimate the total value in US Currency.

The Safety Net

This is a good time to drive home the concept of what I call the safety net for beginners in trading Forex.

A trade movement of 100 pips is considered significant. Notice that when a micro lot is used, a gain of 100 pips is only $10.

For a $1,000 trading account, that equates to a very modest 1%. Nothing to shout home about.

However, if this happens to be a loss of 100 pips, you won’t suffer a big drop in your $1000 account. You have a feeling that you can live to trade another day and have a reasonable chance of making up that $10 loss.

What if you threw caution to the wind and used a mini lot to make that trade? The respective gain would be a credible $100. However, a corresponding loss would also be $100.

Your trading account will now have been depleted down to $900, a loss of 10%. This hurts.

It will take a lot of skill and some luck for a beginner to bring their account back to $1,000. At least they still have an account to trade, and use this as a learning experience.

The Worst Case Scenario

Let’s say you felt lucky and decided to go all out and make a trade using a single lot. Wouldn’t this be an easy way to double your account? Consider, just a few 100 pips win and you could be sitting on an account worth several thousand dollars. Right?

Not so fast now. What would happen in the 100 pip loss case? You got it right. You will have wiped out your $1000 account and be left with zero. Yikes!

Essentially you are now dead in the water, Unless you can come up with more funds to trade with, your trading days, or even hours are over.

Yes, you can experience 100 pip movements in a few hours or even less than an hour. It depends on what is happening in the financial markets to influence large swings.

What Exactly Is The Safety Net?

Pure and simple, it is to NEVER make a trade using a lot size greater than one micro lot.

The aim of a beginner is not to get rich trading Forex. Instead, the aim is to learn to trade skillfully to make a boatload of pips!

When you can prove to yourself that you can end each month with an increase for example 400 pips, that would be amazing. Here’s why.

Once you are able to accumulate a larger trading account, say $10,000, you can now trade using single lots. At the end of the month when you see that 400 pip gain, that would be the equivalent of a $4,000 profit since a one pip gain is about $10. 400 pips X $10 = $400.

There are many other factors to create a solid safety net and I will go into more detail in future articles. So stay tuned!

The Power Of Consistency

Let’s take this a step further. A 400 pip gain is a lot, right? It is. What would it take to get there?

If you only traded 4 days a week and earned an average of 20 pips a day, that seems very reasonable. Nearly all traders can do this. This adds up to 100 pips a week, and about 400 pips a month.

Why doesn’t every trader with a $10,000 trading account and can trade in one lot size become rich? The answer is very simple.

It is extremely hard to become a CONSISTENT trader and make 20 pips on average a day, month after month, after a month. Most traders can achieve impressive wins in one month, only to lose it and then some in the next month when their trading goes south.

The reward of using Forex trading to create future wealth is well worth becoming a consistent trader. Just imagine the possibilities you will have when you have the financial resources to back you up.

A Hard Lesson

One of the hardest lessons in Forex trading is to develop the mindset, psychology, knowledge, and skills to become a consistent trader. Do not neglect this aspect of your training.

Any trader can find a trading situation where they can make a gain of 100 pips. If they can do that, they can also find conditions that will lose them 100 pips. Easy come easy go holds very true here.

It is far better to earn 20 pips a day on average consistently for months and months. Those who can, do indeed become very rich.

Once you succeed at trading consistently, can you imagine trading not only with one lot per trade but also with two or three lots per trade? As your capital account increases to $100,000, you can make a single trade using more than one lot.

This can turn that $4000 monthly profit into $8000 and $12,000 a month and more without making any additional effort. Can you see the importance of growing your capital? A successful trader can grow their account exponentially.

That will be the subject of another article.

Future Direction Of My Forex Posts

I have only just scratched the surface of Forex trading. In future posts, I will cover topics like how to open a Forex account and set up a demo account. How to become really good at risk management. And many others.

Which Forex pairs are best to focus on as a beginner, and why. How to read the charts and set up trades. When to enter and exit trades. Criteria are necessary to set up Stop Loss and Take Profit levels.

What indicators do I use and why? Exposure to other indicators. How news can affect trading results.

Where do I go to get my knowledge and skills? And much, much more.

Suggested Future Reading From My Site

In the meantime, I suggest you read my introductory post on Forex. Click the title below:

How To Make Money In Forex? – The Magic Formula!

I wrote this two years ago in my early days of affiliate marketing training. The thought of developing a category in Forex hadn’t even entered my mind.

At that moment in time, I was not ready to develop a Forex niche because it was too early in my education on Forex and Affiliate Marketing. Now I am ready to go!

Next read the article I recently published on the Psychology of Forex trading, link below?

What Is The Psychology Of Forex Trading? Success Secrets!

I hope you find all these articles and the ones to come helpful. These are not directed at experienced Forex traders. If you happen to be one who is reading my articles. I welcome any feedback and insights you care to give.

Closing Thoughts

As a thank you for reading this article till the end, I want to give you a free gift. An eBook copy of one of the earliest and most effective self-development books ever written.

The iconic Think and Grow Rich by Napoleon Hill.

No matter how much knowledge and skills you have, without developing the right habits to use these consistently, success will allude you. There it is again, the power of being consistent.

When you fill in your name and email address in the form below, I will also be able to notify you by email when I am publishing a new post on my website with a summary of what it is about.

I wish you much success in your entrepreneurial activities whatever that may be.

Cheers!

Edwin