Question: What is the "Pip Value" and "Cross Rate"? How do I calculate them?
In brief and general, pip is the smallest price change that a given exchange rate can make.
The currency quotes appear as numbers with either two or four decimal places.
This means that if the Foreign Currency moves up or down, the smallest move is called a “pip”.
Therefore defining “1 pip” for each currency pairs is dependent on the exchange rate given to the related pair.
Pip value refers to the amount of money we gain/loss for each pip we gain or lose in currency trading.
The easiest way to find out pip value of a currency pair is by observing how much money you gain/loss for each pip you gain/loss when you are in-trading, no matter what your trading platform is. That is the practical way.
Even though a pip is only a small amount of money, because your foreign currency trading is usually a leveraged investment, a few pips can mean serious cash fluctuations.
Each serious trader needs to know how to calculate the change from pips the actual sums invested.
To do manual calculation you need to know what “1 pip” is for related currency pair.
Below are the formulas to calculate pip value:
Direct Rates: Currency pairs with USD as the quoted currency
Currency pairs where the USD is the quote currency are referred to as direct rates.
This holds true for currency pairs such as GBP/USD, EUR/USD, AUD/USD, NZD/USD.
Pip Value = Tick Size * Trade Size
For an example, let’s take EUR/USD with 4 decimal points price quote (e.g 1.2455).
If you trade 1 lot (1 standard lot, equal to USD 100,000 trade size), the pip value will be:
Pip Value = 0.0001 * 100,000 = $10
If you trade 0.1 lot (1 mini lot, equal to USD 10,000 trade size), the pip value will be:
Pip Value = 0.0001 * 10,000 = $1
Indirect Rates: Currency pairs with USD as the base currency
Most currencies are traded indirectly against the U.S. Dollar (USD), and these pairs are referred to as indirect rates.
An example is the USD/CAD (Canadian Dollar).
The USD is the base currency, the CAD is the quote currency and the rate quote is expressed as units per USD.
Pip Value = Tick Size * Trade Size/Current Price
For an example, let’s take USD/CAD with 4 decimal points price quote and current price is 1.0323.
If you trade 1 lot (1 standard lot, equal to USD 100,000 trade size), the pip value will be:
Pip Value = 0.0001 * 100,000 / 1.0323 = $9.69
If you trade 0.1 lot (1 mini lot, equal to USD 10,000 trade size), the pip value will be:
Pip Value = 0.0001 * 10,000 / 1. 0323 = $0.969
Calculation of Cross Rates – Example
Currency pairs that do not involve the USD are referred to as cross rates.
Even though the USD is not represented in the quote, the USD rate is usually used in the quote calculation.
An example of a cross rate is the EUR/GBP where the EUR is the base currency and the GBP is the quote currency.
Pip value = Tick Size * Trade Size * Base Quote/Current Rate
Let’s take EUR/GBP with 4 decimal points price quote.
The EUR/GBP is currently traded at 0.8078 and EUR/USD is currently trading at 1.2455.
If you trade 1 lot (1 standard lot, equal to USD 100,000 trade size), the pip value will be:
Pip Value = 0.0001 * 100,000 * 1.2455/0.8078 = $14.42
If you trade 0.1 lot (1 mini lot, equal to USD 10,000 trade size), the pip value will be:
Pip Value = 0.0001 * 10,000 * 1.2455/0.8078 = $1.442
How to calculate Profit and Loss in Forex Tradings?
All FOREX trading platforms automatically calculate the Profit & Loss of a trader’s open or closed positions. However, it is useful to understand how this calculation is formulated.
To illustrate an FOREX trade, consider the following two examples:
Example 1
Let’s say that the current bid/ask for EUR/USD is 1.4616/1.4619, meaning you can buy EUR for 1.4619 or sell EUR for 1.4616.
Suppose you decide that the Euro is undervalued against the U.S. Dollar.
To execute this strategy, you would buy Euros (simultaneously selling U.S. Dollars), and then wait for the exchange rate to rise.
So you make the trade: to buy EUR 100,000 you pay $146,190 (100,000 * 1.4619).
Remember, at 1% margin, your initial margin deposit would be approximately $1,461 for this trade.
As you expected, Euro strengthens to 1.4623/1.4626.
Now, to realize your profits, you sell EUR 100,000 at the current rate of 1.4623, and receive $146,230.
You bought EUR 100,000 at 1.4619, paying $146,190.
Then you sold EUR 100,000 at 1.4623, receiving $146,230.
That’s a difference of 4 pips, or in U.S. Dollar terms ($146,190 – $146,230 = $40).
Total profit = US$40.
Example 2
Now, let’s say that we once again buy EUR/USD when trading at 1.46160/1.4619.
To buy EUR 100,000, you pay $146,190 (100,000 * 1.4619).
However, Euro weakens to 1.4611/1.4614.
Now, to minimize your loss, you decide to sell EUR 100,000 at 1.4611 and receive $146,110.
You bought EUR 100,000 at 1.4619, paying $146,190.
You sold EUR 100,000 at 1.4611, receiving $146,110.
That is a difference of 8 pips, or in U.S. Dollar terms ($146,190 – $146,110 = $80).
Total loss = US$80.
