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Why a PIP is the Key To Trading
There are about twenty odd definitions for the word “PIP” in Urban Dictionary. Some would make a sailor blush. But for us forex traders pip only means one thing -- it’s the smallest unit of change in the market. It’s what we chase all day. It’s how we measure our success. In short -- for those of us who day trade the currency market a pip is what we live for.
But what if we are doing it all wrong? What if the word itself holds the clue to a much better way of doing business?
A pip in FX stands for “percentage in point” and it’s that word percentage that we should never forget.
Almost every trader I know, yours truly included, makes the mistake of evaluating himself on pips made or dollars earned. On the surface that makes sense but in reality this is not only stupid but can be very harmful to your long term financial health.
Looking at pips made is probably the dumbest way to evaluating your success. Four out of five days I actually lose more pips than I make, but thanks to the marvel of the VT system my net P/L is usually positive. This week, one of the best traders in my room shared his myfxbook results in our room and he too showed a lot of bleeding on the pip front, but his actual account was up 5% since the start of this month!
Pips in and of themselves do not matter. What really matters when you trade is how much size you use on your winning pips versus the size on your losing pips.
A second common way of looking at your account is even worse. Don’t ever brag to me about how much money you made. That is almost a guarantee that you will lose it all. I understand that ultimately the purpose of trading is to make money -- but the irony of this business is that if you focus on money -- you will never make any. That’s because when you encounter an unexpected loss ( and let’s be honest -- they are all unexpected) you’ll start to think about how much money is being drained to the market and you will hesitate just long enough -- an hour, a day, a week -- to totally blow up your account.
A much better, more professional way of looking at your account is to measure your wins and losses strictly on a percentage basis. Looking at the value of your account that way does two things -- it abstracts the actual money involved so that it really doesn’t matter whether you trade 1000 or 1 Million units and it keeps you focused on what’s important which is managing your P/L so that day in and day out you add 20, 30, 50 basis points to your equity. Most importantly it allows you to plan for maximum loss in percentage terms and also provides you with the ability to plan on how to recover those losses. For example in my trading plan my max loss on any trade cycle is 125 basis points which I know from prior experience I can recapture with 1-3 days of proper trading.
The key thing about this approach is that you are never in a situation where you face risk of ruin by letting one trade take 50% of your account. If you think in percentage terms, every trade is just a basis point win or loss. It’s never personal, is just business which exactly how it should be if you want to succeed in trading.