In the forex market, the “percentage in points” (PIPS), equal to 0.0001, is the basic unit to measure the change of a currency price or the difference between two currency prices. It is used to measure all the currency pairs but the Japanese yen, which is quoted only to the second decimal point. Interpreting PIPS in terms of profits and losses often creates troubles to new traders.
In order to understand how to read PIPS, a trader has to observe which currency is listed first in the exchanged pair of currencies. In the spot market, the first listed currency indicates which currency is being bought or sold and is called the “base currency”. The base currency allows a trader to determine whether the measured pips represent a profit or loss. For example, let’s analyse the GBPUSD currency pair and suppose the ask price is $1.4000. The pound sterling is the base currency because it is the first listed in the pair (left hand side), while the U.S. dollar is the quoted currency (right hand side), used to buy or sell the pound, and is expressed in terms of one unit of the pound.
If a trader believes that the pound will appreciate, then he would take a long position, that is, he will buy the pound. The ask price is from the market maker’s perspective so this indicates that a trader can buy one pound for $1.400 U.S. dollars. If a trader takes a long position on the GBPUSD (i.e. he buys the pound) and the measured pips are positive, this means he gets a profit. If he takes a short position (i.e. he sells the pound) and the measured pips are negative, he suffers a loss.
To measure the change in a currency price, a trader must subtract the new quote from the old one. Let’s assume that a trader takes a long position on the GBPUSD and the pound appreciates against the dollar. Let’s suppose that the bid-price (i.e. the price a dealer is now willing to buy at) is now $1.405. This means that the pound has appreciated by $1.4005 – $1.4000 = $0.0005 against the U.S. dollar. Or, counting from the fourth decimal place, the profit the trader gets is equal to 5 PIPS.