If you are just starting out in forex trading, you may be finding it hard to make sense of all of the specialized vocabulary. Even the most basic concepts can have hidden complexities – this is certainly the case with pips and spreads.
A pip does measure the change in value of a currency – it is the smallest price change that any currency can make. Most pips are equal to a 0.0001 price change. For instance, the EUR/USD currency pair price might change from 1.4030 to 1.4031 – this is a one-pip movement.
However, there is an exception to this definition of a pip. Where a currency has a low unit value, the price is only quoted to 2 decimal places, not 4. In this case, a pip is 0.01 rather than 0.0001. The best example of this is the Japanese yen – if the USD/JPY currency pair increases from 104.22 to 104.23, this is a one-pip change.
The other important thing to remember about pips is that not all pips are equal. The value of a pip is tied to the denominating currency in a currency pair. Therefore, a 100-pip rise in CAD/USD is the same as a 100-pip rise in GBP/USD – both are a rise of one US cent. However, when the denominating currency is different, then a pip does not have the same value. For instance, a 100-pip rise in USD/CHF is a rise of 1/100 of a Swiss franc, not one US cent.
Buy orders are executed at the higher ask price, while sell orders are executed at the lower bid price. This means that if a trader buys and then sells immediately, they will always lose the amount of the spread. Because of this, forex traders generally look for low spreads, since the spread is the equivalent to a tax – although a private one – on each transaction.
Of course, the money that traders lose on spreads has to go somewhere. In fact, the spread ends up with the market maker or broker – this is where they make their profits. This is also why forex trading typically doesn’t involve commissions, since the broker’s profit is already built into each trade.
What does a pip mean?
You may have come across terms such as making 400 pips of profit, which would seem to indicate that a pip is some sort of currency value. However, the situation is actually a little more complicated than that.A pip does measure the change in value of a currency – it is the smallest price change that any currency can make. Most pips are equal to a 0.0001 price change. For instance, the EUR/USD currency pair price might change from 1.4030 to 1.4031 – this is a one-pip movement.
However, there is an exception to this definition of a pip. Where a currency has a low unit value, the price is only quoted to 2 decimal places, not 4. In this case, a pip is 0.01 rather than 0.0001. The best example of this is the Japanese yen – if the USD/JPY currency pair increases from 104.22 to 104.23, this is a one-pip change.
The other important thing to remember about pips is that not all pips are equal. The value of a pip is tied to the denominating currency in a currency pair. Therefore, a 100-pip rise in CAD/USD is the same as a 100-pip rise in GBP/USD – both are a rise of one US cent. However, when the denominating currency is different, then a pip does not have the same value. For instance, a 100-pip rise in USD/CHF is a rise of 1/100 of a Swiss franc, not one US cent.
How does this relate to spreads?
When the price of any currency pair is quoted, there are actually two prices. The first is the bid price – this is how much is being offered for the currency pair. The second is the ask price – how much sellers are asking. The difference between the two is called the spread and is measured in pips.Buy orders are executed at the higher ask price, while sell orders are executed at the lower bid price. This means that if a trader buys and then sells immediately, they will always lose the amount of the spread. Because of this, forex traders generally look for low spreads, since the spread is the equivalent to a tax – although a private one – on each transaction.
Of course, the money that traders lose on spreads has to go somewhere. In fact, the spread ends up with the market maker or broker – this is where they make their profits. This is also why forex trading typically doesn’t involve commissions, since the broker’s profit is already built into each trade.
Editors’ Picks
EUR/USD stays defensive below 1.1750 as USD finds its feet
EUR/USD kicks off the new week on a softer note, holding below 1.1750 in European trading on Monday. The pair faces challenges due to a pause in the US Dollar downtrend, with traders shifting their focus to the delayed US Nonfarm Payrolls and CPI data for fresh directives. The ECB policy decision is also eagerly awaited.
GBP/USD holds steady above 1.3350 as traders await key data and BoE
GBP/USD remains on the back foot above 1.3350 in the European session on Monday, though it lacks bearish conviction and holds above the key 200-day SMA support. The US Dollar holds its recovery mode ahead of key data releases, while the Pound Sterling faces headwinds from the expected BoE rate cut this week.
Japanese Yen adds to strong gains and drags USD/JPY to 155.00 amid hawkish BoJ bets
The Japanese Yen extends its steady intraday ascent through the Asian session on Monday, dragging the USD/JPY pair to the 155.00 psychological mark in the last hour. Against the backdrop of the recent shift in rhetoric from Bank of Japan Governor Kazuo Ueda, an improvement in business confidence reaffirms market bets for an imminent rate hike this week.
Editors’ Picks
EUR/USD stays defensive below 1.1750 as USD finds its feet
EUR/USD kicks off the new week on a softer note, holding below 1.1750 in European trading on Monday. The pair faces challenges due to a pause in the US Dollar downtrend, with traders shifting their focus to the delayed US Nonfarm Payrolls and CPI data for fresh directives. The ECB policy decision is also eagerly awaited.
GBP/USD holds steady above 1.3350 as traders await key data and BoE
GBP/USD remains on the back foot above 1.3350 in the European session on Monday, though it lacks bearish conviction and holds above the key 200-day SMA support. The US Dollar holds its recovery mode ahead of key data releases, while the Pound Sterling faces headwinds from the expected BoE rate cut this week.
Gold climbs to seven-week highs on Fed rate cut bets, safe-haven demand
Gold price rises to seven-week highs to near $4,350 during the early European trading hours on Monday. The precious metal extends its upside amid the prospect of interest rate cuts by the US Fed next year. Lower interest rates could reduce the opportunity cost of holding Gold, supporting the non-yielding precious metal.
Solana consolidates as spot ETF inflows near $1 billion signal institutional dip-buying
Solana price hovers above $131 at the time of writing on Monday, nearing the upper boundary of a falling wedge pattern, awaiting a decisive breakout. On the institutional side, demand for spot Solana Exchange-Traded Funds remained firm, pushing total assets under management to nearly $1 billion since launch.
Big week ends with big doubts
The S&P 500 continued to push higher yesterday as the US 2-year yield wavered around the 3.50% mark following a Federal Reserve (Fed) rate cut earlier this week that was ultimately perceived as not that hawkish after all. The cut is especially boosting the non-tech pockets of the market.
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