To those unfamiliar with financial markets, the words “pips,” “points,” and “ticks” may sound like something out of a Dr. Seuss book. But there’s a reason why these units of measurement exist in the trading lexicon. In order to assess risk and reward and understand profits and losses, it’s important to know what these terms mean in different contexts.
In the stock market, points represent the whole dollar amount by which a given stock or stock index has increased or decreased. In the case of an individual stock, a single point is always equivalent to one U.S. dollar. For example, if a stock dropped from $53 to $48, the change would be expressed as a five-point drop (as opposed to a five-dollar drop). So what, you may ask, is the point of using points?
Although the dollar value of a point remains consistent across different stocks, the percent change in share value that a single point represents depends on the value of the stock in question. For instance, if a $30,ooo stock dropped by three points, those three points represent a mere 0.01 percent drop in share value (3/30,000 x 100). In contrast, if a $10 stock were to drop by three points, that same three-point delta would plummet the share value by 30 percent.
In the context of a stock index, i.e., a collection of stocks, a single point change doesn’t necessarily represent a one-dollar market shift. In other words, a one-point drop in the Dow Jones Industrial Average doesn’t mean that all 30 stocks in the index fell by a sum total of one dollar. In fact, some stocks in the index may have risen, while others fell by varying amounts. Instead, a Dow point represents a one-dollar change in the weighted average of share prices for the index. Because stock indexes typically include a variety of high-priced stocks, using points in place of dollars allows price changes to be communicated in a more succinct way, with emphasis placed on collective performance.
To complicate things further, there are a couple of additional “points” to keep in mind with regard to the financial marketplace. In bonds trading, for example, a single point represents a one percent change in the bond’s value. As such, the dollar value of a point is subject to change as a bond increases or decreases in price. In the context of futures contracts, a single point is equal to two percent of a penny, or $0.0002.
A tick is a fractional price change in a stock or security that is less than one dollar and as low as one cent. The tick value, or tick size, is used to establish a minimum increment by which price changes can be measured in a given market. Although different markets have different tick sizes, once that tick size is established, incremental price movements below that threshold cannot be tracked. For example, if the tick size of a stock was $0.10, a change of $0.05 would not be reflected in price movement. Instead, the stock price would increase or decrease by multiples of $0.10, moving from $40 to $40.10, $40.20, and so on.
In stocks trading, ticks can also be used to indicate the direction that closing price has moved relative to prior trades. In this context, an uptick is used to describe an increase in price and a downtick refers to a decrease in trading price. Prior to 2007, an uptick rule created by the SEC stipulated that all short sale transactions (e.g. when a trader expects price to decrease and borrows an asset in the hopes of selling it and repurchasing it at a lower price) be made at a higher price than previous ticks. The purpose of this original uptick rule was to prevent short traders from collectively depreciating the stock price. In 2010, the SEC replaced it with the alternative uptick rule, which only applies when a stock’s price has plummeted by 10 percent within the span of a single day. Once this 10 percent loss threshold has been met, the alternative uptick rule grants trading precedence to sellers taking a long position, thus restricting short selling in order to combat downward market pressure.
Pips (points in percentage) are unique to the foreign exchange market (Forex) and measure fractional price changes for currency pairs. In Forex, most currency pairs are priced to the ten-thousandths decimal place (four digits after the decimal point). Similar to a tick, a pip represents the smallest increment, or basis point, by which a currency pair can increase or decrease in price. Because pips refer to a currency pairs rather than a single stock or security, their value reflects the relationship or “spread” between the two currencies in question.
After a currency trader enters into a position, profits and losses are expressed in terms of pip movement relative to that position. For example, imagine that a trader uses euros to buy U.S. dollars, anticipating a rise in the relative value of the dollar to the euro. If that trader purchased dollars at a rate of €1.6740 per dollar and sold their USD (thus exiting the trade) at a rate of €1.6765 per dollar, their profit would equate to 25 pips.
The value of those 25 pips depends on the amount of USD that the trader bought. In other words, if they only bought one USD, a 25 pip profit would only equate to a few fractions of a euro. In contrast, if they bought four million USD (at a cost of €6,696,000), a 25 pip profit would mean that they were paid €6,706,000, thus earning a €10,000 profit.
Before acting on a trade, make sure that you understand the meaning and value of points, ticks, or pips relative to the market and trade in question. Armed with this knowledge, you’ll be equipped to interpret the financial implications of market movements and weigh risks, rewards, profits, and losses with greater accuracy.
The information provided herein is for general informational and educational purposes only. It is not intended and should not be construed to constitute advice. If such information is acted upon by you then this should be solely at your discretion and Valutrades will not be held accountable in any way.