what is a Pip

Pips

Using a broker to trade currencies is a lot different than doing the normal buying and selling through a money changer or a bank. It is more interactive and you can instantaneously react to major economic events as they unfold across the globe. Unlike stocks or commodities in which you could only trade during business hours, Forex brokers stays open since a financial center somewhere on the other side of the world should be open when it is night time on your current time zone, you could trade whenever a major significant economic news came out in Japan that would directly affect its currency.
Currency brokers provide tight spreads when buying or selling currencies and would make you think that rates over a money changer are ridiculous. Spread is the difference between the rate in which you could buy the currency and the rate where you could sell it. For example at a local bank you could buy the British Pound at $2.06 per Pound and sell Pounds at $2.00 per Pound. The spread is 6 cents ($2.06 - $2.00 = $.06) that is about 600 Pips. Currency brokers on the other hand offers spreads as low as 3 Pips. A pip or basis point is 1/100 of a percent. This is the smallest increment in price movement.

In Forex, a pip is 1 basis point which is the lowest price movement of a currency. Each pip represents a profit or loss point depending on the number of lots traded. A lot is a group of individual goods bundled together to form a set standard quantity that would form as a single unit set by exchanges or an institution. In currency trading a lot would be composed of 10,000 pieces of notes ($10,000) for a mini account, and 100,000 pieces of a unit of currency as a standard ($100,000).

For example, if you trade a single standard lot of EUR/USD the pip value would be $10. Should the price increased 3 pips, you gained $30 from that move because each pip costs $10, but when the price dropped 5 pips you lost $50.

The trade shown above is buying Euros and selling US dollars, the standard lot size which is 100,000 is not of the US dollar but of the Euro. You bought 100,000 Euros in this transaction and sold $142,000 USD. Buying the same amount of Euros at current exchange rate with your US dollars at the bank and selling it at the same pip movement would produce the same profit. Basically we had $142,000 and bought Euros. ($142,000 US dollars / $1.4200 per Euro = 100,000 Euros) When the rate moved 13 pips, we exchange it back to US dollars. (100,000 Euros X $1.4213 per Euro = $142,130 US Dollars) We subtract the principal from our revenue to determine profit. ($142,130 - $142,000 = $130 Profit)

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