22.What is Spread and Pip?
Forex is a global market, and traders constantly look for opportunities to make money. One way to do this is to find markets where the price is not yet settled and spread your investments across these markets to maximize profits.
This is called pip trading. Pip stands for price per unit, so when you spread your investment across multiple contracts, each with its own pip value, you are essentially trading individual currency units.
What are Pips in Forex?
Forex trading is a highly popular investment opportunity that allows traders to profit by exchanging currencies. For traders to make informed decisions, they need to understand what pips are and how they can be used in the market.
Pips are units of measure used in Forex. They are often used to indicate the price movement of one currency unit against another and can be very useful for forex traders.
They serve as a way for traders to measure the difference between two currencies and provide valuable information about market movements.
Because pips change frequently, it is important for forex traders to have a solid understanding of them to make sound decisions.
What is the difference between Pip and Spread in Forex?
Forex is a global market where different currencies are traded against each other. Pip and spread are two of the most common forex trading terms.
Pip (symbol: “p”) is the smallest currency trading unit used to quantify the movement in the currency. The spread is the difference between the bid and offer prices for a particular currency pair.
Generally speaking, in EUR/USD, the fourth decimal place is the pip unit, while in USD/JPY, due to the pricing of the Japanese Yen, the second decimal place is the pip unit.
When the EUR/USD appreciates from 1.1840 to 1.1849, we could say that the euro was up nine (9) pips against the dollar. When it comes to the spread cost, the spread of EUR/USD from forex brokers is about three pips or less. This means that, for the standard contract, the spread cost for one contract (commonly defaulted as 100,000 units) is $30.
New investors should be aware of the difference between the bid price and the asking price of those currency pairs in FX trading. This is just a normal market condition. For example, there is a difference between bid-ask prices in stock trading and real-time streaming of stock quotes.
What is a Basis point (BP)?
A Basis point, also known as BP, is a financial term that refers to the smallest unit of a financial instrument, such as stocks, bonds, or currencies.
The basis point is also used in accounting to measure the price movement of an asset or liability over time. Financial institutions and investors use basis points to calculate and determine the value of investments.
Difference between PIP (P) and Basis Point (BP)
In the forex market, Pip is a unit of calculation that refers to 1/100 of a currency unit. BP might be mistaken as Pip by new investors in forex trading.
In practice, BP will not be used in forex trading because it describes changes in bonds and interest rates.
Basis points are important because they help analysts and traders calculate investment risks. For example, if you own one (1) share of stock and the stock’s value increases by 100 basis points (1%), your share would be worth $1.01 rather than $1.00.
A basis point equals 0.01%. For example, after the meeting of the FOMC, when it comes to rate hikes or rate cuts, 25-basis-points are often mentioned in the Fed’s decision.
Apart from the BP and PIP, Tick and Point are very common in expressing price movement, but newbies may easily misunderstand those differences.
Why is there an extra decimal place in the currency pairs quotation?
As mentioned above, a pip is a minimum change in price movement in the forex market. Still, most trading platforms now display an extra decimal place on the quote, which may cause misunderstanding of the traditional definition of 1 pip.
In fact, this is related to the development of the financial markets. Since the financial crisis in 2008, the technology and communication network have become increasingly advanced, and mind-boggling amounts of data can be processed at the same time efficiently.
In addition, financial companies generally attach great importance to information technology developments so that now brokers can be inter-connected to the forex market in many ways. With faster and more efficient transfers of data information, the market quote has become more refined and can offer 1 / 10 units of 1 pip, making the spread narrower correspondingly.
This benefits investors because a narrower spread means less trading cost. The competition among forex brokers is still fierce, so most of them quote this extra decimal place to clients. As a result, investors may interpret one pip differently over time.
Next Article: 23. What is pip value?
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