Pips and Their Value
No one can engage in forex trading without understanding what pips are and how to calculate the value of a pip. In a nutshell, a forex pip is the smallest figure used to describe the value of a certain currency as compared to another. The pip is the last digit after the decimal point in the exchange rate of the base currency into the target currency, it is the smallest figure in the number showing how much of the base currency you must pay in order to buy 1 unit if the target currency.
For most forex currencies the pip will be the fourth digit after the decimal point, an exception to this rule is the Japanese Yen, this currency's pip is the second digit after the decimal point.
For instance, if you plan to trade dollars for Euros the exchange rate may be 1.5326, this means you must pay 1.5326 U.S dollars in order to buy one Euro, the number for the forex pip in this case is 6, the last digit describing the value of the Euro in terms of U.S dollars.
Calculating the Value of Forex Pips
Once you know which figure constitutes the forex pip you need to be able to tell the value of a single pip, this will allow you to figure out how much you're paying in terms of commission and, even more importantly, how much you've made or lost at the end of a trade.
Perhaps the easiest way to tell the value of a forex pip is to understand what fraction of which currency it stands for. For instance, if the U.S dollar/Euro exchange rate is 1.5326 then the figure 1 stands for 1 dollar, the 5 (first figure after the decimal point) is 5o cents, the 3 is 3 cents, the 2 is 2 tenths of a cent and the 6 stands for 6 one hundredths of a cent. This means the monetary value of each forex pip in this case is one hundredth of a cent.
All of the above is true when dealing with a single unit of the base currency. In forex trading we make trades for far greater sums. In order to calculate the value of each pip in a particular transaction we need only multiply the figure we came for a single unit by the sum we're trading.
When trading on the pair U.S dollars to Euros the value of the pip forex for 1dollar is one hundredth of a cent. If we're buying 100,000 Euros at 1.5326 U.S dollars per Euro we'll be paying 152,326 U.S dollars each pip in this transaction is one U.S dollar.
Naturally we need not make these calculations ourselves. Using the forex pip calculator makes it easy to tell the value of a pip for any trade we're making.
Spreads and Daily Fluctuations
Once you know what is a pip in forex you need to understand forex spreads so that you can determine what the potential for gain is and ultimately how much money you’ve made (or lost). The forex spread is the difference in pips between the exchange rate at the beginning of a trade and at its end. For instance, if you're trading US dollars for Euros, the exchange rate you bought 100,000 Euros for was 1.5236 and you sold the Euros back for U.S dollars at an exchange rate of 1.5343 then the spread is 107 pips, which amounts to 1.07 dollars.
Fluctuations are swings in exchange rates. The average fluctuation for the USD/Euro pair is around 100 pips, 50-60 pips on calmer days and up to 300 pips on turbulent days. With more volatile currencies average daily fluctuations may be far greater which means the potential for profits is greater but with it also a risk of suffering substantial losses.