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Close alert You've unfollowed this author. You won't receive any more email notifications from this author. If you are just starting out in forex trading, you may be finding it hard to make sense of all of the specialized vocabulary. Even the most basic concepts can have hidden complexities — this is certainly the case with pips and spreads. What does a pip mean? You may have come across terms such as making pips of profit, which would seem to indicate that a pip is some sort of currency value.
However, the situation is actually a little more complicated than that. A pip does measure the change in value of a currency — it is the smallest price change that any currency can make. Most pips are equal to a 0. However, there is an exception to this definition of a pip. Where a currency has a low unit value, the price is only quoted to 2 decimal places, not 4. In this case, a pip is 0. The other important thing to remember about pips is that not all pips are equal.
The value of a pip is tied to the denominating currency in a currency pair. However, when the denominating currency is different, then a pip does not have the same value. How does this relate to spreads? When the price of any currency pair is quoted, there are actually two prices. The first is the bid price — this is how much is being offered for the currency pair. The second is the ask price — how much sellers are asking.
The difference between the two is called the spread and is measured in pips. Buy orders are executed at the higher ask price, while sell orders are executed at the lower bid price. This means that if a trader buys and then sells immediately, they will always lose the amount of the spread.
Because of this, forex traders generally look for low spreads, since the spread is the equivalent to a tax — although a private one — on each transaction. Of course, the money that traders lose on spreads has to go somewhere.
In fact, the spread ends up with the market maker or broker — this is where they make their profits. What are Pips and Spreads in Forex?More...