What is a pip?
A pip is the smallest full unit of movement in a financial market, standing for Percentage in point. Whether that is a forex currency or a CFD such as the Dow, Dax or FSTE it is simply a unit of measurement. Pips start at different decimal points depending on what you are trading and often there is a fractional pip shown.
As a quick example, an Index CFD such as the DOW has pips in whole numbers, so if it moves from 15755 to 15756, or an increase of 1 in price, that has moved one pip. FX on the other hand uses decimals and this might vary depending on the fx pairs you are looking at. For the AUDUSD, whole pips are to 4 decimals and one pip of movement might be something like a movement from 0.67073 to 0.67083, ignoring the final decimal (in this case a 3) as a fractional pip. So you are looking at the 4th decimal moving from 7 to 8 in this example. The JPY Yen crosses throw in an added layer of complexity, where they go to the 2nd decimal. Again, let’s say 107.510 moves to 107.520, this would be 1 pip, ignoring what the fractional pip (in this case 0) is doing.
You might hear the term pip, but it is sometimes called a tick or a point also. These can be used interchangeably. If you ever get into coding algorithms, the word tick may also mean whenever there is any movement in price, known as an OnTick () function in MQL4 and MQL5. In general terms, the three words above (pip, tick and point) are used interchangeably for manual trading.
When using a MetaTrader platform, you might use the Crosshair tool to measure from on price to another to see how many pips that move would be. This tool generally shows pips including the fractional, meaning that 1 pip will show as 10, 3 pips shows as 30 and 300 pips shows as 3000. The crosshair displays the information as follows:
Price of the symbol / Bars (candles) / Points or pips
When you place the crosshair in one place, click down and drag it to your desired location to measure, the three pieces of information will be shown and reflect the position you have dragged the tool to. Let’s say you want to measure a move from one point to another in history. You start it at one of the points, and drag the crosshair to the other point. The other point you drag it to shows the price of your crosshair, how many bars this move took and the pips of the move. The bars help you to see how long the move took based on the timeframe of the chart. You chart might be on a 1 hour (H1) chart and you know that each candle represents one hour of movement. If your crosshair measured 7 bars on the 1 hour chart, you know that would be 7 hours. If you were on a 1 day chart (D1) that would mean the time of the move you are measuring is 7 trading days (remembering the weekend as there are only 5 trading days a week).
Remember, while it is important that you know enough about trading, knowing words and terms won’t necessarily help you trade better. Focus on making good decisions when you buy, sell and exit positions. Knowing what a pip is will only help you talk to others about trading. A pip is simply a unit of measurement, just like a builder works in millimetres, gridiron players work in yards and feet. These are simply a distance from one point to another, just as a pip is from one point to another.
Why do people care about pips?
If you know the pips profit and maximum loss pips of a strategy, you can get a good idea of how much you might be able to make from that strategy based on how much money you would be risking on that strategy. If you are a beginner, focus on the concept of a strategy and trading techniques as you have a while to go before you need to understand pips and the below example. As an example, if you traded a strategy that makes an average of 10 pips per month, you can reverse engineer your needs to see how much you want to make and risk on the strategy. Let’s look below for more:
10 pips average profit per month
20 pips max drawdown
You want to earn $1,000 per month so you would need to set your volume or lots traded to make that 10 pips worth $1,000. How do you do that though? Well, often $10 per pip can roughly be looked at as 1.00 of volume (this will change on what you are trading). So roughly, a volume of 1.00 equating to $10, multiplied by 10 pips gives $100 ($10x10pips = $100). If we need $1000, we can reverse engineer this by the pips, by dividing the amount needed, by the pips or $1000 / 10 pips = $100 per pip required. Often to roughly convert a $ per pip value into lots, you would divide it by 10, so $100 per pip divided by 10 = 10 lots or volume to trade. If you know the pips of a strategy, you can work out how much money you need to put on each trade for that strategy to earn a predictable outcome.
The risk side is also important. The above example shows a 20 pip maximum drawdown, meaning the biggest loss period was down by 20 pips. Knowing you are going to trade at a set pip value, you can work out how much drawdown you might experience throughout trading the strategy. The worst point in time experienced in this strategy shows that you could be down by 20 pips and at 10 lots/volume this would mean an approximate loss of $2000. This doesn’t mean you lose money overall, but you would be taking on trades throughout this period and your account would go down before it goes up to earn you money again. This would mean you would need the $2000 in your account to maintain your ability to trade, plus the margin requirements to place new trades.
Just to clarify, the $2000 in this situation is the worst case experienced during the strategy over a period of time, not an overall loss. So you might have 3 months of winning 10 pips per month, making $3000 profit, then the bad trades hit and your drawdown is $2000, leaving you with $1000 profit. The next month you could be back on the winning side and earn 10 pips again bringing you back up to $2000 in profit all up.