WHAT EXACTLY ARE PIPS?
First and foremost, “PIP” is an abbreviation for Point In Percentage. The 1/100th place – two places to the right of the decimal point – in all currency pairs involving the Japanese Yen (JPY) is referred to as a PIP. When it comes to all other currency pairs, a pip is the 1/10,000th place – which is four positions to the right of the decimal point.
Allow me to provide you with a simple example to ensure that we are all on the same page: If you bought the EURUSD at 1.0000 and subsequently closed your trade-in profit at 1.0010, you would have made a profit of 10 pips on your investment.
THE MOST OFTEN MISTAKEN PERCEPTION OF PIPS
Many websites and traders will brag about how many “PIPS they snagged this month,” and you should pay attention to this. In the majority of situations – and to be completely honest – this is extremely deceptive, as most beginner traders erroneously believe that this is an accurate indicator of one’s level of skill.
A point in time (PIP) is simply a fractional change in price and has no direct link to the current transaction unless we take a few variables into consideration beforehand.
PIPS are only useful if you’ve determined what the average PIP was in relation to the deal in question and the technique employed by the trader.
How do we determine the PIP VALUE and how do we calculate it?
First and foremost, the exchange rate shows the amount of the quote currency that is required in order to get one unit of the base currency in your possession. Let’s have a look at an example to make this point perfectly clear:
The current value of the pound against the dollar is 1.61250.
The base currency is the pound sterling. The currency that has been quoted is the United States dollar (USD). Assuming your broker permitted you to trade only one unit at a time, the Base in this example would be GBP 1, and the quotation would be USD 1.6125. In other words, £1 would get you $1.61.
Everyone knows that no broker will enable you to trade in such little increments (fractions of a cent!).
Now that we’ve covered the fundamentals, it’s time to figure out what each PIP number represents. To put it another way, if you do a standard-sized deal with your broker, how much (in monetary terms) does one PIP shift in the exchange price of the pair in issue cost you?
In order to figure out how much each PIP is worth in the “Term Currency” (as opposed to the traders’ denominated trading currency), the following is the fundamental formula:
Value per PIP = ( PIP / Exchange Price ) × Lot Size (Units) x ( PIP / Exchange Price )
In order to illustrate this, consider the following example of adding 0.10 (10,000 units) to the price of GBP|USD we just looked at:
$0.62 (term currency – not the denominated trading currency) is equal to (0.0001 / 1.61250) x 10,000 = $0.62 (denominated trading currency).
It’s all quite straightforward! To put this into reality, let’s look at some hypothetical traders to determine if PIPS is truly a standardised means of measuring the profitability a trader’s performance…
HYPOTHETICAL TRADERS (to make things simple!): forex Trader 1 Trader 2 Trader 3 Trader 4
Sally exclusively trades the EURUSD currency pair. She only ever trades with a 0.10 lot each transaction (10,000 units). She has a trading account in GBP worth £1,000 that she uses to make purchases. She employs hard stops of 20 PIPS, but she also intervenes from time to time to limit her losses earlier.
As of today, Sally’s closed transactions appear as follows:
EURUSD – Buy: +23 pip on the day
Euro to Dollar (EURUSD): Sell: -17 PIPS
EURUSD — Sell at a -20 PIPS loss.
Sally’s overall PIPS score is -14 PIPS.
Sally, as we’ve already established, like fixed lots. As a result, calculating the value of a PIP is straightforward for us:
(1.27450) x 10,000) = 0.78 (0.0001 EURUSD (1.27450)) = 0.78
For example, if Sally makes a 0.10 trade, each point of difference (PIP) move (more than the spread) either for or against her will be worth €0.78. We would want to know how much each PIP is worth in Sally’s trade currency, though (GBP).
Simply multiplying €0.78 by EURGBP (0.78916) equals £0.61 – Pip value per 10,000 units is all we have to do. The following is an example of how her trades appeared in her denominated trading currency:
Purchase of EURUSD at a profit of +23 PIPS multiplied by £0.61 equals a profit of +£14.03 pips.
Profit on the EURUSD trade: -17 PIPS x £0.61 = -£10.37 loss.
-20 PIPS multiplied by £0.61 equals -£12.20 profit on the EURUSD trade.
Sally’s total loss was -£8.54 or -0.85 percent of her original GBP trading balance of £1,000 (£1,000 GBP).
Because each PIP is valued the same under the current conditions, we now know that when Sally tells us how many PIPS she has produced, she is in fact providing us with a fair way to evaluate her profitability.
Trader No. 2
James trades the EURUSD, GBPUSD, and AUDJPY, among other currencies. The lot size he uses is determined by a proportion of his existing trading balance in relation to the stop distance in points per second (PIPS). Whenever he engages in a single trade arrangement, he risks 1.5 percent of his closed account balance. He maintains a trading account in the amount of $5,000 USD. He also has regulations in place that require him to trade only when the risk-to-reward ratio is at a minimum of 1:1.
The following are James’ closed deals as of today:
EURGBP – Buy: +65 PIPS GBPUSD – Sell: +40 PIPS AUDJPY – Sell: -190 PIPS EURGBP – Buy: +65 PIPS GBPUSD – Sell: +40 PIPS
The total PIPS for James are: -80 PIPS.
James completed the day with a PIPS deficit. In monetary terms, on the other hand, he is really ahead in his trading account. The reason for this is that James treats every pair in the same manner as he would any other pair in terms of risk profile. Just before placing the three transactions, he performed the following calculations to ensure that he was well prepared:
Current Trade Balance: $5,000 USD multiplied by 1.5 percent (risk) equals $75.00 USD (risk)
Trade 1 EURGBP: James intends to strategically set his stop loss 45 PIPS away from his entry price in order to maximise his profit. He then does the following calculations in order to determine what lot size he should be utilising in order to accommodate his 1.5 percent risk profile :
45 PIPS divided by $75 equals $1.66 per PIP.
What is the value of PIP per 1,000 units (0.01) of EURGBP on the exchange rate? The product of (0.0001 / EURGBP 0.79040 ) multiplied by 1,000 is €0.12 (term currency)
Afterwards, he wishes to know how much each PIP is worth in terms of his own trade currency: €0.12 multiplied by EURUSD (1.27400) equals $0.16
Recall point 1 above; take $1.66 and divide it by $0.16 to get 10.3 – rounded down to 10 = 10,000 units or 0.10 lots of currency.
As a result, James traded the EURGBP with a lot size of 0.10 units. He made a profit of +45 PIPS on the transaction, resulting in a monetary gain of +$72. (rounded in deposit currency)
In accordance with the rules outlined above, each transaction James enters has the same monetary risk in terms of the closing balance. PIPs are absolutely meaningless to him because he entertains his risk profile by sizing his lots dynamically. Furthermore, he is only concerned with the risk-to-reward ratios of various investments. Consequently, the following is what James’ account balance looked like at the conclusion of the day:
Euro to British Pound – Buy: +45 PIPS = +$72.00 (approx. example)
The pound to the dollar is now trading at +40 PIPS, or +$72.00. (approx. example)
AUDJPY – Sell: -190 PIPS = -$72.00 on the AUDJPY (approx. example)
The total PIPS for James are: -80 PIPS.
Overall, James made a profit of $72.00 (give or take a few cents), or a 1.44 percent increase on his starting $5,000 USD trading balance.
As you can see, the trading styles of these two traders are extremely different. Fixed lots and PIP stops/targets are two of Sally’s favourite trading strategies. James, on the other hand, carefully puts his stops in the trades so that he may achieve at least a 1:1 (R:R) ratio. Due to the fact that stop and target distances from the entry price might change from trade to trade, James is never concerned with the number of PIPS he has or has not earned. Keep in mind that the lot size he employs is always related to the risk profile (percentage) of his closed account balance, rendering PIPs entirely superfluous in his trading operations.
Hopefully, this has made some individuals more aware of the fact that PIPs are, in the majority of situations, a non-standardized method of determining a trader’s skill in the market. A lot of so-called “professional” traders place a lot of emphasis on their PIP statistics, which is bad since they are taking advantage of the fact that the average beginner retail trader believes they are all created equal. It is for this reason that several educational websites have purposefully displayed the “pips they bagged” this week. For the most part, this is why some traders can have thousands of PIPs won and then suffer a single PIP loss of 100/s, which can wipe away a significant portion ( percent ) of their account value.
So, what exactly should I be looking at?
“R Multiples” are the most accurate and conventional method of determining how much someone has risked in exchange for the return they have received. Observers will no longer be required to compute how much each PIP was worth, and traders will be able to view the risk/reward ratio, which will help them decide whether or not to trade a certain pair of coins.