A pip is a unit of measurement for price movements of currencies in foreign exchange (FX) markets. Pip stands for “percentage in point” or “price interest point.” It represents the smallest price variation that a particular exchange rate experiences based on typical FX market convention.
Currency pairs are generally traded on a pricing convention that includes four decimal places (called the “big figures” or “big figs”), with the pip representing the very last digit. Therefore, we can see that a pip is equivalent to 0.0001. It is also the same as a basis point (bps), which is another common unit of measurement for 1% of 1% percentages.
As an example, if the CAD/USD exchange rate were to move from 1.2014 to 1.2015, the change in value would represent one pip.
A pip is a unit of measure for price movements in foreign exchange (“forex” or “FX”) markets.
Most commonly in FX market convention, pricing includes four decimal places and a pip is the last digit, or 0.0001.
Pips are very important in forex markets because price movements are constant and fast-paced, so pips are needed to track these movements to a fine degree of accuracy.
Why Use Pips
Since FX markets are highly liquid with a high volume of transactions, the units of measurement for transactions are important. Furthermore, since units are typically quite small, a larger number of decimals are needed to capture variations in exchange rates to a greater degree of accuracy.
Pips cannot be used in every context though, and in an environment of hyperinflation in currencies, exchange rates become difficult to calculate with pips. Hyperinflation refers to a period where prices of goods and services are increasing excessively and in an out-of-control fashion. When FX movements become extremely high, pips lose their utility.
A strong example was recorded in Zimbabwe in the year 2008, where monthly inflation rates exceeded 79 billion percent in the month of November. When hyperinflation occurs, units of currency increase at an extraordinary rate which makes the small measurement of pips useless.
How are Pips Used in FX Markets?
An important measure in trading is the bid-ask spread. It represents the difference between what price a buyer pays at and what price a seller receives at.
In FX markets, the spread would be represented in the difference between these numbers would be the spread, measured in pips. This bid-ask spread also represents the profit that will be made by the FX broker of a transaction if they are able also to find a matching transaction on the other side.
For fast-moving markets, the big figs in the pricing of an FX price are largely omitted as the market makers assume that it is understood. As the market now moves towards electronic trading, it isn’t as much of an issue, even in volatile markets, but on voice trades, there is a higher chance of execution error, so experienced market practitioners will always confirm big figs after the trade to ensure both parties agree.
So, for example, if we look at an example EUR/USD quote of 1.1009/14, the bid/offer spread is 5 pips, or 5 basis points.
While the bid/offer 1.1009/14 in entirety, a spot FX trader via a voice trade may quote the pips as “09-14” and the counterparty is expected to know the rest.
Thank you for reading CFI’s guide to Pip. To keep learning and developing your knowledge base, please explore the additional relevant resources below: