CFD stands for contracts for differences

When it comes to online trading, you face a lot of unknown terms that should be defined. One of the terms online traders often search for is “pip”. Understanding this term is necessary for all traders, especially those dealing with CFD. Why is it so, and what does a “pip” mean? To figure this out, we need to examine and answer three basic questions:
  1. What is CFD trading?
  2. What is a “pip”?
  3. How to calculate pips in CFD trading?

When we answer all these questions, by the end of the guide, you will learn what you came for. So let’s get down to business!

What is CFD trading?

The abbreviation CFD stands for contracts for differences. When you buy contracts for differences, you don’t obtain ownership over underlying assets. This means that CFDs are derivative products that provide you with the possibility to speculate on price movements in different financial markets, including foreign exchange, stock, and commodities. You benefit from price changes without adding assets to your portfolio.

How do you profit when trading without owning assets? If your forecasts are right, you gain the difference between the buy and sell prices of the asset. This is why CFD trading might be so beneficial – you don’t need to take time until product prices become higher because the difference will be paid to you even if you bet on the declining movement of the value.

At the same time, it’s necessary to realize that CFD trading is quite risky. Mainly, risks are caused by a lack of liquidity. So to understand how this product works and how to benefit, you should have in-depth knowledge of the markets and terms of online trading.

What is a “pip”?

In online trading, the term “pips” is used not only for CFDs. But if we talk about CFD instruments specifically, let’s define that a “pip” represents the minimum amount of value change of the underlying. This change is needed to take place before the change of the value in the CFD instrument.

Pips are usually expressed as decimals. For example, if a pip of CFD is $0.01, the instruments’ value changes by every cent-change in the value of the underlying instrument.

Let's imagine the situation to make sure you understand how it works. You trade CFD on stocks. Let’s consider you bought a TSLA stock at $179.05. If the stock’s value increases to $179.06 or drops to $179.04, the change represented is 1 pip in either an increasing or declining direction.

Bear in mind that pips for CFDs are different across the markets. In the example, we examined the situation in the stock market when one pip is worth $0.01. However, the nature of the forex market, for instance, is different. Consequently, one pip may equal 0.0001 for certain currency pairs.
How to calculate pips in CFD trading?

After learning the basics about CFD trading and the meaning of a “pip” in CFD trading, you might have a logical question: how do I calculate a value of a pip when trading contracts for differences in different financial markets?

This is not a big challenge to figure this out. To do this, you need to examine the CFD Contract Specifications that are represented by your trading platform. These specifications explain the value of one pip for a chosen forex pair or stock assets. Note, that some trading platforms can refer to pips as points. In CFD Contract Specifications, they provide both the meaning and value of one pip/point.

Final word

This isn’t an ultimate guide on CFD trading. This niche is far more complicated than we explained, we only covered the basics. We hope that thanks to this guide, you now know what a “pip” means in CFD trading and will be able to use this knowledge when practicing in real-market conditions. We suggest that you first should take some time to risk-free practice on a demo account of your favorite platform. Once you finish your free trial, try to implement all the experience and knowledge you gain!