Pips & currencies

Most experienced forex and currency futures traders will have learned that at one time or another, how to calculate the value of a forex pip, which is the smallest incremental change in value in a currency pair. This computed quantity is also sometimes known as the pip value for a particular currency pair. The following article will provide you with a comprehensive explanation of how, you too, can accurately calculate a pip value.

There are two ways to calculate the pip value. The right method to select depends on whether a trader wants the pip value to be expressed in base currency terms or in counter currency terms.

Knowing the pip value of a currency pair that is actively in trading, often helps a forex trader to be able to quickly determine gains or losses on a forex position – in terms of either the base currency or counter currency.

Both manners of calculating pip value for typical forex rates are described below.

Calculating Pip Value in Base Currency Terms

A typical forex rate quotation expresses the amount of the counter currency that has an equivalent value to one unit of the base currency. For the USD/JPY currency pair, the exchange rate is the amount of Japanese Yen — the counter currency — that is equivalent in value to one U.S. Dollar — the base currency.

To calculate the value of a pip in USD/JPY in U.S. Dollar or base currency terms, the following equation can be used:

(Size of a Pip) / (Exchange Rate) x (Base Currency Notional Amount) = Pip Value

The standard pip size for USD/JPY is 0.01. If the USD/JPY exchange rate is currently 100.00 Yen per Dollar, and the notional amount you are trading is $100,000, then the corresponding pip value is:

(0.01) / (100.00) x ($100,000) = $10.00

This means that a one pip move in the exchange rate will have a $10.00 impact on the value of your $100,000 position.

Calculating Pip Value Counter Currency Terms

To calculate the value of a pip in EUR/USD in U.S. Dollar or counter currency terms, the following equation can be used:

(Size of a Pip) x (Base Currency Notional Amount) = Pip Value

The standard pip size for EUR/USD is 0.0001. If the notional amount you are trading is 100,000 Euros, which is the base currency, then the corresponding pip value is:

(0.0001) x (100,000 Euros) = $10.00

This means that every pip move in the EUR/USD exchange rate will have a $10.00 impact on the value of a 100,000 Euro position.

When Pip Values are Constant and When They are Not

As you can note from the first equation above, the pip value expressed in base currency terms for a base currency notional amount fluctuates inversely, with changes in the exchange rate. This means that, as the exchange rate rises, the pip value gets smaller and, as the exchange rate falls, the pip value rises.

Nevertheless, the pip value, which is expressed in counter currency terms for a base currency notional amount, remains constant and does not vary along with the exchange rate, which gets cancelled out of the equation.

This explains why currency futures contracts, such as those listed on the Chicago IMM that are traded in base currency notional amounts, have a constant pip value of $1.00 per 10,000 base currency units.