The term PIP refers to a unit of movement in the price of a financial asset and is more commonly used in the currency market, also known as the forex market. Although stock traders and investors rarely worry about PIPs, it is useful to understand the kind of price change the term refers to and why it is more relevant in other realms of trading.
Definition
The term PIP stands for Percentage in Points and equals one hundredth of one percent. A move from 100 to 100.01 would represent a one PIP advance, for example. A single PIP, in other words, is an extremely small change and is usually inconsequential in most cases. The price of most financial assets, whether bonds, stocks or options, is not quoted in such small increments, and therefore a jump of a single PIP is usually impossible except in the case of currency trading.
Currencies
The currency markets moves in extremely small increments and moves as small as a single PIP are therefore possible in currency trading. The price of one euro, quoted in term of U.S. dollars, for example, may indeed go from 1.3015 to 1.3016 representing a one PIP advance. While it is hard even for currency traders to profit from a single PIP change in prices, moves as small as five PIP do present profit opportunities in the currency market. This is because foreign exchange traders greatly leverage their positions, meaning that they trade with large sums of borrowed money. A professional trader may use $300,000 of her own money and borrow a further $2.7 million. When trading with $3 million a single PIP gain represents $300; still not an enormous sum, but enough to make a living if you catch a dozen such moves on an average day.
Stocks
Very few stock traders talk about PIP because a single PIP advance or decline in stock prices is rarely noteworthy. Stocks move far more aggressively than currencies and, in most cases, the smallest move up or down in a stock far exceeds a PIP. A stock priced at around $10 may move up or down in 1 cent increments, which represents 10 PIP.
Commissions
Another reason stock traders rarely talk about PIP is that commissions in the stock market are far higher than in the currency market. A stock trader profiting, who registers a 1 PIP or even 5 to 10 PIP in profits, will usually pay more in commissions to his broker than his profits. Therefore, stock traders are not nearly as excited by a PIP and you will hear the term come up far less frequently with regard to stock trading.
References
Writer Bio
Hunkar Ozyasar is the former high-yield bond strategist for Deutsche Bank. He has been quoted in publications including "Financial Times" and the "Wall Street Journal." His book, "When Time Management Fails," is published in 12 countries while Ozyasar’s finance articles are featured on Nikkei, Japan’s premier financial news service. He holds a Master of Business Administration from Kellogg Graduate School.