Submitted by Jim Thesiger on 17 October, 2010 - 00:37

Pip refers to the smallest unit of price which is traded for a currency. In other words, pip is the smallest change of price that occurs in case of a given exchange rate.

Considering the fact that most of the major currency pairs are priced up to four decimal points, the smallest change is that of the fourth decimal point. This is equivalent to the 1/100 of one percent (also known as one basis point) in case of most of the currency pairs. If you consider the pair of US and Canadian dollar, you can say that the smallest price movement that can happen in case of the USD/CAD is $0.0001 or one basis point. Although usually the smallest price movement in case of most of the currency pairs is $0.0001 or one basis point, the smallest change does not necessarily have to be one basis point in all cases.

As far as currency trading is taken under consideration, pips are used for calculating the spread which is linked with the difference between a bid and offer. Say for example, assuming that Pound Sterling against the US dollar is currently at 1.7241/48, a forex trader will be able to buy Pound Sterling at the offer price of 1.7246 while on the other hand will be able to sell it off at 1.7241. Here the difference between the bid and offer will be the spread which in case of this particular example is five pips.

You will find majority of the brokers offering a narrow spread when it comes to the most liquid currency pairs like AUD/USD and EUR/USD where the spread can be as low as two pips. Usually the active or day traders find the currency pairs most attractive in cases where every pip matters. Currency pairs with low liquidity will usually come with wider spread. The USD/CAD currency pair can be a good example of that.

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