First off, “PIP” stands for Point In Percentage. In all pairs involving the Japanese Yen (JPY), a PIP is the 1/100th place – 2 places to the right of the decimal. In all other currency pairs, a pip is the 1/10,000th place – 4 places to the right of the decimal.
Anything smaller than a PIP is known as a “PIPETTE”. This is 1/10th of a PIP. “Pipettes” was introduced by major retail brokers in the early to mid 2000’s. They’re fractional pips that merely provide the trader more precise pricing. Some retail brokers today however, still display their quotes to the 4th decimal place.
You will find a lot of websites and traders mention how many “PIPS they bagged today or this month“. In most cases – and frankly put – this can be very misleading as most novice traders perceive this as a fair measurement of ones proficiency.
A PIP is merely a fractional change in price and has literally no direct relationship to the given trader unless we consider a few factors first.
PIPS are only important once you determine what value the average PIP was relative to the trader at hand and strategy adopted.
GBP|USD current exchange price: 1.61250
The Base currency is GBP. The quoted currency is USD. Assuming your broker allowed you to trade just 1 unit, in this example the Base would be GBP 1, and the quote was USD 1.6125. Meaning £1 would get you $1.61
As we all know, no broker allows you to trade that small (fractions of a penny!).
Right, now armed with these basics, we now want to find out what each PIP value is. That’s to say, placing a usual sized trade with your broker, how much (monetary) is one PIP move in the exchange price on the pair in question?
This is the basic formula to work out what each PIP is worth in the “Term Currency”(i.e. not the traders denominated trading currency):
- ( PIP / Exchange Price ) x Lot Size (Units) = Value Per PIP
So placing a 0.10 (10,000 units) on the price we just looked at on GBP|USD looks like this:
- ( 0.0001 / 1.61250 ) x 10,000 = $0.62(term currency – not denominated trading currency)
Pretty simple stuff! Let’s look at some hypothetical traders so that we can put this into practice and see whether PIPS is really a standardized way in determining a traders profitability…
Sally only trades the EURUSD. She only ever places a 0.10 lot per trade (10,000 units). She has a £1,000 GBP denominated trading account. She uses hard stops of 20 PIPS but sometimes intervenes to cut her losses sooner.
Today Sally’s closed trades look like this:
EURUSD – Buy: +23 PIPS
EURUSD – Sell: -17 PIPS
EURUSD – Sell: -20 PIPS
Sally’s Total PIPS: -14 PIPS
As we know already, Sally uses fixed lots. Therefore, the value per PIP is easy for us to figure out:
( 0.0001 / EURUSD (1.27450) ) x 10,000) = 0.78
So when Sally’s places a 0.10 trade, each PIP move (greater than the spread) either for or against her will equate to €0.78. However, we want to know what each PIP is worth inSally’s trading currency (GBP).
All we do is take the €0.78 x EURGBP (0.78916)= £0.61 – Pip value per 10,000 units. Now we can see what her trades looked like in her denominated trading currency:
EURUSD – Buy: +23 PIPS x £0.61 = +£14.03 Profit
EURUSD – Sell: -17 PIPS x £0.61 = -£10.37 Loss
EURUSD – Sell: -20 PIPS x £0.61 = -£12.20 Profit
Sally’s Total Loss: -£8.54 or -0.85% on her initial £1,000 GBP trading balance.
Therefore, we now know that when Sally tells us how many PIPS she has made, this does in-fact equate into a fair means of evaluating her profitability as each PIP is worth the same under the given circumstances.
James trades the EURUSD, GBPUSD and AUDJPY. The lot size he places is based upon a percentage of his current trading balance, relative to the stop distance in PIPS. He always risks 1.5% of his closed account balance on any-one trade setup. He has a $5,000 USD denominated trading account. He also has rules to only trade if there is a 1:1 risk:reward ratio as a minimum.
Today James’ closed trades look like this:
EURGBP – Buy: +65 PIPS
GBPUSD – Sell: +40 PIPS
AUDJPY – Sell: -190 PIPS
James’ Total PIPS: -80 PIPS
James finished the day down on PIPS. However, in monetary terms he is in fact up in his trading account. The reason why is because James treats every pair exactly the same with regards to his risk profile. Just before he placed the 3 trades, he did the following calculations first:
Current Trade Balance: $5,000 USD * 1.5%(risk) = $75.00 USD(risk)
Trade 1 EURGBP: James strategically wants to place the stop loss 45 PIPS away from his entry price. He then does the following calculations to figure out what lot size he should be using to entertain his risk profile of 1.5%:
- 45 PIPS / $75 = $1.66 per PIP
- What is PIP value per 1,000 units (0.01) on EURGBP? = ( 0.0001 / EURGBP 0.79040 ) x 1,000 = €0.12(term currency)
- He then wants to know what each PIP is worth in his own trading currency: €0.12 x EURUSD (1.27400) = $0.16
- Revisit point 1 above^, take $1.66 and divide by $0.16 = 10.3 – rounded down is 10 = 10,000 units or 0.10 lots.
Therefore, James traded the EURGBP with a 0.10 lot size. He made on the trade +45 PIPS, which is a monetary gain of: +$72(rounded in deposit currency)
Using the following principles above, each trade James places has the same monetary risk, relative to the closing balance. PIPs are completely irrelevant as he entertains his risk profile through dynamic lot sizing. Further more, he is only concerned with risk:reward ratios. So here is what James’ account balance looked like at the end of the day:
EURGBP – Buy: +45 PIPS = +$72.00(approx. example)
GBPUSD – Sell: +40 PIPS = +$72.00(approx. example)
AUDJPY – Sell: -190 PIPS = -$72.00(approx. example)
James’ Total PIPS: -80 PIPS
James’ Total PROFIT: $72.00(give or take some) or +1.44% gain on his initial $5,000 USD trading balance.
As you can see both traders, trade in very different ways. Sally likes to use fixed lots and PIP stops/targets. Whereas James strategically places his stops in the trades where he aims for at least a 1:1 (R:R) ratio. James is never concerned about how many PIPS he has or hasn’t made because each trade can vary in stop and target distances from the entry price. The thing to remember is, the lot size he uses is always relative to the risk profile (%) of his closed account balance making PIPs completely redundant.
In a nut-shell, that is why some traders can have 1,000’s of PIPs gained and then take a mere 100/s PIP loss that wipes out a huge chunk (%) of their account balance.
More on this in future blogs!