In forex trading, traders come across various concepts and terminologies that need to be clarified initially. Two of the most commonly used terms are forex pip and forex spread, and although they are related, they represent different things. In this blog, we will discuss the differences between forex pip and forex spread, along with some examples to help you understand them better.
Table of Contents:
Forex pip
A forex pip, short for percentage in point, is the smallest unit of measurement used to represent a change in the price of a currency pair. It is typically the fourth decimal place in most currency pairs, except for currency pairs that involve the Japanese yen, where it is the second decimal place. A pip’s value depends on the trade’s size and the traded currency pair. A pip is used to calculate the profit or loss on a trade.
For example, let’s consider the EUR/USD currency pair. Suppose the current exchange rate of EUR/USD is 1.2000, and you have purchased 1 lot (100,000 units) of EUR/USD at this rate. If the price increases by 10 pips, the new exchange rate will be 1.2010. Your profit, in this case, will be calculated as follows:
Forex spread
A spread is the difference between a bid and an ask price. A bid price is a price at which a market maker is willing to buy a currency pair, and an asking price is a price at which they are willing to sell it. The spread is typically measured in pips, the smallest unit of measurement in forex trading. The spread affects the cost of trading, as traders must pay the spread every time they enter and exit a trade.
For example, let’s consider the USD/JPY currency pair. Suppose the bid price is 110.50 and the asking price is 110.55. In this case, the spread is 5 pips. If you want to buy USD/JPY, you must buy at the asking price of 110.55. If you want to sell USD/JPY, you must sell at the bid price of 110.50. Every time you enter or exit a trade, you must pay the spread, which is 5 pips.
Key differences between forex pip and forex spread
The main differences between forex pip and forex spread are:
- A forex pip is the smallest unit of measurement used to represent a change in the price of a currency pair, while a forex spread is a difference between the bid price and the ask price of a currency pair.
- Forex pip calculates the profit or loss on a trade, while forex spread affects the cost of trading.
- Forex pip is measured in pips, while forex spread is measured in pips.
Bottom line
Forex pip and spread are important concepts in forex trading that represent different things. Forex pip calculates the profit or loss on a trade, while forex spread affects the cost of trading. Traders should clearly understand these concepts to make informed trading decisions.