When you trade forex, you’re buying or selling a currency pair – such as EUR/USD, GBP/USD, or USD/JPY. Let’s take a closer look at the anatomy of forex pairs.
The first currency in a pair is known as the base currency. The second is known as the quote currency (or sometimes as the counter currency). The price of a pair tells you how much of the quote you’ll need to buy a single unit of the base.
Say, for example, that EUR/USD is trading at 1.3010. The euro is the base, and the US dollar is the quote – meaning it costs 1.3010 dollars to buy a single euro. Forex traders look to profit from fluctuations in the exchange rates of currency pairs. So, if you think that the US dollar is going to strengthen against the Japanese yen, you might buy EUR/USD to capitalize on the move.
What is a pip?
A pip is a single point of movement in a forex pair. In most FX pairs, a pip is equivalent to a single-digit move in the fourth decimal point of a currency pair’s price. If EUR/USD moves from 1.0717 to 1.0718, it has moved up one pip.
One important exception to this rule is currency pairs where the Japanese yen (JPY) is the quote currency. Here, a pip is equivalent to a single-digit move in the second decimal point. If USD/JPY moves from 110.08 to 110.03, it has moved down five pips.
This is because the yen is worth comparatively little to other major currencies.
Fractional pips
You’ll often see an extra fifth digit after the pip on a Forex quote. These are referred to as fractional pips (or pipettes). Sometimes, they’ll be written in superscript (smaller font size) to differentiate them from pips.
Calculating the value of a pip
A pip is worth 0.0001 (or 0.01%) of a single unit of the quote currency. That means you have to trade 10,000 units of the base currency to earn one unit of the quote for each pip of movement. The amount of the base currency you trade is known as your lot size.
To earn $1 for every pip that EUR/USD moves, for example, you’d have to trade the equivalent of €10,000.
Remember that a pip is worth 0.01 (or 1%) of the base currency when the quote is the yen? If you traded $10,000 of USD/JPY, you’d earn or lose ¥100 for each pip that USD/JPY moves.