It’s not about the pips, and certainly not about the dollars. Learning to accurately measure your success or failure in each trade is essential to survival…
Forex Pip 1
Don’t get fooled into thinking the forex pip is the building block of trade measurement; it isn’t!
You’ve no doubt heard or read the boasts of supposedly successful traders talking about how much they made yesterday, last week or last month or whatever.
When you first start out in forex trading these impressive claims have the twin effect of making you feel inferior and putting you in awe of the people making them.
If you are in this position now rest assured that you needn’t feel that way.
First off, the really successful traders never boast. They just don’t need to. They are comfortable with who they are.
Secondly, when you have a close look at the claims very few of them stand up to scrutiny.
This is almost always because of the manner in which the vaunted success is measured. All told, there are four main ways of measuring the success of any individual trade or set of trades. Let’s look at those four now.
The first measurement is the most ridiculous: it’s when a trader talks about how many dollars or euros or substitute-any-currency-you-like they have made. The claim is ridiculous for two reasons:
Because what may be a large amount of money to them may be peanuts to you, or vice versa
Because it doesn’t tell you how much of their account they put at risk in order to make those dollars. For example, if they made a thousand dollars yesterday on a trade but their risk in the trade based on where their stop loss was set amounted to five thousand dollars, that’s a very, very poor trade and nothing to be proud of. It’s even worse when you discover that they did not set a stop loss, because in that case obviously their risk was only limited by the size of their account!
The second measurement is probably the most common: Forex Pips. “I had a fantastic day yesterday, I made over three hundred pips” you’ll hear it said. But once more, we have no inkling of how much was at risk in making those three hundred pips. If it was on a single trade and the risk was one hundred pips, that’s a good trade by anybody’s standard. But if they had to risk a thousand pips in order to make those three hundred, it’s obviously a different story.
It becomes even murkier when you do know how much they risked but they are talking about a basket of trades. “I took twenty trades last week and made over three hundred pips, with an average risk of fifty pips per trade”. Now you have to do the maths: twenty trades at fifty pips risk per trade equals one thousand pips. Again, on scrutiny the profit doesn’t seem so great.
Some traders take it a step further and use the third measurement of trade success: Percentages. So a trader will talk about having made 5% on their account in a single trade. This gives perhaps a little clearer picture but has the same shortcoming as the previous methods, in that it doesn’t equate risk to reward. Once more, if they made 5% on their account by putting a total of 10% at risk it was not such a great trade after all.
This brings us to the fourth and ultimate measure of trade success: Units. When using this concept we are directly measuring Return as a fraction of Risk. Simply put, one Unit equates to one measure of risk. Let me explain.
I have a trading account of one thousand dollars. I decide never to risk more than a certain amount, let’s say 1% of that account – ten dollars – in any single trade. I call this amount risked a single Unit, or Position. So, if I make twenty trades over a given period of time, I have risked twenty units of my account:
20×10 dollars equals $200 risked, or 20 units risked. Now I can say that for every ten dollars I make in return, I have profited one unit. So if I made $500 my real profit is:
500 divided by 10 dollars equals 50 units. A good result based on the 20 units risked.
Forex Pip 2
Learn to think as a battlefield commander: how many units do you risk for the possible gain?
Using this process of measurement we know immediately how well a trader has done. If they say “I made two units on that trade” we know it has been a good trade for them, based on the fact that they have made twice the amount they risked.
Contrast this with the situation where they say I made “I made 2% on that trade”. Here we don’t know how well they did unless we know what percentage they risked on the trade.
I urge all traders to think in terms of units risked and units profited. It is the cleanest and most accurate method I have encountered of realistically measuring success in trading.
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