What is the price unit on Forex?

In order to trade successfully on the foreign exchange market, you need to understand how prices are formed and calculated on Forex. This will allow you to better predict your profit and calculate possible risks in order to minimize them. In this article we will learn what a point is, what the difference between a point and a pip is, and what formulas are used to calculate the value of a point.

Points and pips are terms that traders use to describe price changes on financial markets.

What is a pip?

Pip is short for "percentage in point". A pip is the smallest change that the price of an asset can make. Most currency pairs are priced to five decimal places, and the last fifth digit is the pip. For example, the movement of the GBP/USD from 1.33816 to 1.33819 means that the change is $0.00003 or three pips.

What is a point?

A point, in contrast to a pip, measures changes in the quotes located left of the decimal point. It is the larger unit of measure commonly used on the stock markets. An investor can describe the change in the company's share price from $500 to $505 as five points rather than $5.

On the Forex market, where quote prices change in thousandths and hundredths, the terms “pip” and “point” are interchangeable.However, there is one particular situation that allows you to differentiate these terms in the Forex market. Forex brokers use five-digit and four-digit quotes. As discussed above, the last digit in any quote denotes the minimum price change and is called a pip. In addition, in five-digit quotes like 0.75661, the fourth digit after the decimal point is called a point sometimes. Therefore, if the price changes from 0.75661 to 0.75681, we can also say that the value of the asset has changed by 2 points. In other words, on Forex, a point is sometimes called the fourth digit after the decimal point in five-digit quotes.

Why do we need points in Forex?

Traders use points and pips to estimate potential profit or loss. To do this, you need to find out the price of a point for a particular transaction based on the current exchange rate of the currency pair. Special formulas are used to calculate the cost of one point. The calculation formula depends on the type of quote. Let's consider examples for each type.

How to calculate the cost of a point?

Direct quote:

(Trade currency to USD) x (trade volume in lots) x (contract size) x (point) / (current rate)

GBP/USD = 1.33523

Current rate = 1.33523

Volume = 1 lot

Contract size = 100,000

Point = 0.00001

Cost of a point for the pair (GBP/USD) 1.33523 x 1 x 100,000 x 0.00001 / 1.33523 = $1

Indirect quote:

(Trade volume in lots) x (contract size) x (point) / (current rate)

where the trade currency is the first currency in the pair.

Point = 0.001

Contract size = 100,000

Volume = 1 lot

USD/JPY = 104.100;

Cost of a point for the pair (USD/JPY) = 1 х 100,000 х 0.001 / 104.100 = $0.96

Cross rate:

(Trade currency to USD) x (trade volume in lots) x (contract size) x (point) / (current rate)

where the trade currency is the first currency in the pair.

Point = 0.00001

Contract size = 100,000

Volume = 1 lot

EUR/AUD = 1.62505; EUR/USD = 1.18725;

Cost of a point for the cross pair (EUR/AUD) = 1.18725 x 1 x 100,000 x 0.00001 / 1.62505 = $0.73

When trading Forex, you will constantly come across the concepts of points and pips, however, these concepts are not complicated at all. Just remember the important detail that changes in the last quote digit are measured in pips. Adequate knowledge about Pips and Points is an important part of the theoretical Forex basics that every trader should be familiar with.