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 climbs toward 1.1800 on broad USD weakness
EUR/USD gathers bullish momentum and advances toward 1.1800 in the second half of the day on Tuesday. The US Dollar weakens and helps the pair stretch higher after the employment report showed that Nonfarm Payrolls declined by 105,000 in October before rising by 64,000 in November.
GBP/USD climbs to fresh two-month high above 1.3400
GBP/USD gains traction in the American session and trades at its highest level since mid-October above 1.3430. The British Pound benefits from upbeat PMI data, while the US Dollar struggles to find demand following the mixed employment figures and weaker-than-forecast PMI prints, allowing the pair to march north.
Japanese Yen seems poised to appreciate further; awaits BoJ decision on Friday
The Japanese Yen maintains its bid tone through the first half of the European session on Tuesday which, along with a bearish US Dollar, keeps the USD/JPY pair depressed below the 155.00 psychological mark. The growing acceptance that the Bank of Japan will raise interest rates this week turns out to be a key factor behind the safe-haven JPY's outperformance.
Editors’ Picks
EUR/USD climbs toward 1.1800 on broad USD weakness
EUR/USD gathers bullish momentum and advances toward 1.1800 in the second half of the day on Tuesday. The US Dollar weakens and helps the pair stretch higher after the employment report showed that Nonfarm Payrolls declined by 105,000 in October before rising by 64,000 in November.
GBP/USD climbs to fresh two-month high above 1.3400
GBP/USD gains traction in the American session and trades at its highest level since mid-October above 1.3430. The British Pound benefits from upbeat PMI data, while the US Dollar struggles to find demand following the mixed employment figures and weaker-than-forecast PMI prints, allowing the pair to march north.
Gold recovers above $4,300 as markets react to weak US data
Gold trades in positive above $4,300 after spending the first half of the day under bearish pressure. XAU/USD capitalizes on renewed USD weakness after the jobs report showed that the Unemployment Rate climbed to 4.6% in November and the PMI data revealed a loss of growth momentum in the private sector in December.
US Retail Sales virtually unchanged at $732.6 billion in October
Retail Sales in the United States were virtually unchanged at $732.6 billion in October, the US Census Bureau reported on Tuesday. This print followed the 0.1% increase (revised from 0.3%) recorded in September and came in below the market expectation of +0.1%.
Ukraine-Russia in the spotlight once again
Since the start of the week, gold’s price has moved lower, but has yet to erase the gains made last week. In today’s report we intend to focus on the newest round of peace talks between Russia and Ukraine, whilst noting the release of the US Employment data later on day and end our report with an update in regards to the tensions brewing in Venezuela.
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