If you are steadfast on taking up online forex trading business, I would recommend that you must get your hands on very sound fundamentals about Pips. For an ardent trader involved in global forex trading, the day starts with setting out the target for the Pips and the day ends with ascertaining his Pips balance sheet. I will try to guide you in learning the basics of Pips. It is essential that you must do sufficient math work to understand Pips to get a clear insight on Pips.

What is meant by Pips?

• Well, I would say that Pip is nothing but a fancy name for ‘Point’. Technically speaking, Pip is the smallest increment or decline in the value of the exchange rate. In a much simpler way, you can understand Pip as the last decimal point of any exchange rate. Pip is the acronym for Percentage in Point.
• An illustration of EURO/USD exchange rate of 1.5582 will make the things much better. In this exchange rate the next incremental value would be 1.5583 and the next decline value would be 1.5581. Mathematically the difference is 0.0001 and in forex jargon it is said that the exchange rate has increased or decreased by 1 Pip.
• You must be aware that rates of most of the currency pairs are expressed up to four decimal points except USD/JPY where it is expressed in two decimal points.
• Let us delve further into Pips by considering a fictitious buy/sell trade of EURO/USD. You are expecting that the value of EURO would appreciate in relation to USD. You have decided to buy EURO/USD. Your buy trade is executed at 1.5582. Your speculation turns in your favor and after some time EURO/USD appreciates to 1.5600. You make up your mind to lock the profit and sell EURO/USD. Your sell trade is executed at 1.5599. The difference between buy and sell values is equal to 0.0017. You have gained a profit of 17 Pips. What exactly is 17 Pips in USD terms? Well, we will see it in the next topic.

How to Calculate Pip Values?

• Depending upon the forex pair and the lot size, the value of Pip would change.
• In EURO/USD 1 Pip amounts to 0.0001 and for a standard lot size of 100,000, the effective Pip value works out = 0.0001 x 100,000 = 10 USD. Likewise for a mini lot of 10,000 Pip value is 1 USD. The principle applied to other forex pairs is same but the calculations differ. Quote currency or second currency of the forex pair decides the Pip value in USD terms. For EURO/USD and GBP/USD, the quote currency is USD which makes the calculations simpler. Value of 1 Pip is 10 USD for a standard lot size of 100,000 as mentioned above. For USD/JPY pair, the quote currency is Japanese yen or JPY. Here the value of pip in USD terms is calculated by dividing the Pips by the exchange rate.

Conclusion

You may wonder in what way Pip value is so important in forex trading? Well, in forex currency trading, Pip is the backbone for calculating your profit or loss. During your forex trading training you should concentrate on calculation of profit and loss from forex trading. We will learn calculation of profit and loss from forex trading separately with few examples.

Online forex trading offers number of distinct advantages. Besides real time rates, your profit and loss is calculated on real time basis by the forex trading software and is displayed live online. Even though this is an important advantage in forex trading account but I strongly recommend that you must be aware about the methodology to calculate your profit and loss from forex trading.

Basically there are two straightforward rules for calculating your profit and loss from forex trading:

1. Rule No.1: Whenever the quote currency (second currency) is USD, you can calculate the profit and loss in USD terms by multiplying the number of Pips with 10 USD if the lot size is a standard lot of 100,000. Similarly in case of mini lot of 10,000, the profit and loss from forex trading can be calculated by multiplying the number of Pips with 1 USD.
2. Rule No.2: In case of quote currency other than USD, the profit and loss will be calculated by dividing the number of pips with the exchange rate and then multiplying the result with lot size.

Let us discuss few factual examples on how to calculate profit and loss from forex trading. I have illustrated three examples – one example with USD as the quote currency and two examples with JPY as the quote currency. For simplicity only Long trades (Trades where you buy first and then sell) are considered. The lot size is assumed as standard lot of 100,000 and lot quantity is taken as 1 Lot.

Calculation of Profit and Loss for EURO/USD Trade:

• Buy trade executed at 1.5555 and sell trade executed at 1.5560.
• Profit/Loss = 1.5560 – 1.5555 = 0.0005 OR 5 Pips.
• Since the quote currency (second currency) is USD, profit and loss in USD terms = 0.0005 x 100,000 = 50 USD ALTERNATIVELY profit and loss = 5 Pips x 10 USD =50 USD
• If you are a trader from EURO zone and you wish to calculate your profit and loss in EURO terms then you need to apply basic math. Divide your USD profit and loss by the exchange rate i.e. 1.5560. It works out to 50/1.5560 = 32.13 EURO. This point has been explained just for the academic interest as all the forex trading brokers display your profit and loss in USD terms.

Calculation of Profit and Loss for USD/CHF Trade:

• Buy trade executed at 1.0473 and sell trade executed at 1.0488.
• Profit/Loss = 1.0473 – 1.0488 = 0.0015 OR 15 Pips.
• Since the quote currency (second currency) is CHF (other than USD), profit and loss in USD terms = 0.0015/1.0488 x 100,000 = 143.02 USD.

Calculation of Profit and Loss for USD/JPY Trade:

• Buy trade executed at 108.09 and sell trade executed at 108.30.
• Profit/Loss = 108.30 – 108.09 = 0.21 OR 21 Pips.
• Since the quote currency (second currency) is JPY (other than USD), profit and loss in USD terms = 0.21/108.3 x 100,000 = 193.91 USD.

Wrapping up

Well-timed locking of your profit and booking of your loss in foreign currency trading is the most important trait for being a successful forex trader. Hence the knowledge of how to calculate profit and loss from forex trading plays a very important role in flourishing the online forex trading business.