To trade Forex successfully you need to understand the basics, including the most used terms.
And two of the most important words you’ll hear are “pips” and “spreads”.
The acronym PIP stands for Percentage In Point or Price Interest Point. In Forex trading your profits and losses are measured in pips.
In simple terms a PIP is the smallest value (price) increment a currency can make.
A pip is a number value. In the Forex market, the value of currency is given in pips. One pip equals 0.0001, two pips equals 0.0002, three pips equals 0.0003 and so on.
List of the Best Forex trading platforms
Forex pips allow us to determine a rise or fall in foreign exchange values in percentage terms as an alternative of measuring in currency terms.
Most currencies are priced to four numbers after the point. For example, a three pip spread for EUR/USD is 1.4502/1.4505.
However, of all the major currencies, the price of the Japanese yen does not have four numbers after the point. In an USD/JPY spread the price is only given to two decimal points – so a quote for USD/JPY looks like this: 114.05/114.08. This quote has a three pip spread between the buy and sell price.
An Understanding of Forex Pips and Spreads is Vital
The spread is closely associated with the pip and has a major importance for you as a trader. Forex spreads are also measured in pips.
The spread is the difference between the bid price and ask price (the sell quote and the buy quote) which is the major cost of currency trading. The “ask” is the price at which you buy and the “bid” is the price at which you sell.
Let’s look again at our example: the EUR/USD pair is quoted at 1.4502/1.4505, making the spread equal to three pips.
First of all, the pip spread is your cost of doing business.
In the case above it means you sustain a paper loss equal to 3 pips at the moment you enter the trade. Your contract has to go up 3 pips before you break even.
Generally speaking, the more active and the bigger the market, the lower the pip spread. The smaller and exotic markets tend to have higher spreads. Most brokers will be offering different spreads for different currencies and smaller accounts will generally have higher spreads than bigger regular accounts.
Low Spread Brokers
This means that at any given moment you can get different quotes for the same currency pair, depending on the brokers. If you care about your profit margins, it is important that you find a broker offering a lower pip spread.
However, the low spread is not everything. Be sure you choose a reputable broker. Remember that this is how brokers make money.
Wider spreads result in a higher ask price and a lower bid price. As a consequence, you pay more when you buy and get less when you sell, making it more difficult to turn a profit.
Brokers don’t typically earn the full spread, especially when they hedge client positions. The spread compensates the market maker for taking on risk from the time it executes a client trade to when the broker’s net exposure is hedged (possibly at a different price).