What is a Pip in Forex?

The first step in understanding what a pip is and what’s its role in Forex trading, is to understand the market as a whole and the principles that make it go round. The currency pairs are the cornerstone of Forex and you will wind up selling and buying these currencies, trying to predict how one will fare against the other. As one currency strengthens, the other will lose its value and this changes by the minute, so the slightest oscillations can translate into significant winnings or losses.

Currencies are usually traded to four decimal points, with the exception be the Japanese Yen which is traded to only two decimal points. The pip is the smallest unit of price traded for a currency, so it will be 1% of a cent for regular currencies and one cent for the Japanese Yen. There are no commissions and fees to be paid to the broker, but each transaction will cost you the difference in spread, so it’s only natural to try an decrease it as much as possible.

One way to make sure that the spread remains low is by trading an active pair, also know as a liquid currency pair, with the USD/EUR being the best example. By trading these active pairs you will benefit of spreads as low as two pips, hence reduce the costs of each transaction greatly and maximize your profits. With the high volatility of the market being a serious threat for your income, you shouldn’t have to deal with wide spreads as well, because that would further decrease your potential winnings.

Another method of reducing the spread is by working with a broker that is capable of delivering a narrow spread. This means that the immediate loss associated to buying the currency will be minimal and with an increase of only a few pips you will return to the profitable side. Only after the spread is covered, the further increase in pips will translate into profits, so you have all the motives to look for a broker which offers the narrowest spreads.

Pay attention to the broker’s reputation as well, because although he offers tempting spreads, he might have a spread policy that will hurt your profits. Pip spreads are not guaranteed and if you team up with the wrong broker, you might wind up winning considerably less than with a trustworthy one offering slightly higher spreads.