Ah pip counts. They are like Lady Gaga crossed with Julia Gillard. All show, fancy on the surface, but in reality, has no relevance to anything. You see pip counts sit right next to winning percentages in trading, they need a context to have any relevance. I am living proof of both. I trade full time, yet perform voodoo magic to earn money while losing pips. What the?!
I tweeted this:
Which created all types of confusion for some, wondering how it was even possible. Here was what was causing the confusion:
So on Monday and Tuesday this week I made 14 trades (way too many), finished at +3.2% yet I have lost 13 pips. Sure it is not going to sell me any trading systems, but it makes money, which is all we care about in the end. So how is this possible?
The secret (there is not one, it just sounds dramatic) is in how you start your trading process. This is the order of my thought process when placing a trade:
- How big does the stop need to be?
- Is it with or against the trend?
- What do I want to risk for this trade (in percentage of account)?
- Is the target far enough away to make it worth while?
- That taken in consideration, what is my resultant trade size?
- Gee I am good looking.
The key’s are points 1, 2 and 6. I have two risk strategies.
With the trend, and I am in with 2% risk, against the trend I am in with 1%.
Let’s go back to high school maths class and work out how this can happen. A warning, in high school, I did spend more time looking at “figures” than figures, if you know what I mean.
The AUDUSD has a pip value of $1 or $10 depending on your account type and unit size. To make it simple for my tiny tiny brain, we will run with $1. Let’s go with the scenario of buying the AUDUSD with a spread size of 1.6 (the actual figures as of time of writing). My account size is $10,000 and I am going to place a trade with a 10 pip stop risking 2% of my account.
Accepted risk = Balance * Risk % = $10,000 * 2% = $200
Let’s take that amount, divide it by the stop size (plus the spread as we pay that as well), and we can find out the value per pip for the trade:
Pip value with the trend – $200 / 11.6 = $17.24
So if this is the value of a pip on a trade with the trend, logic says a trade against the trend with a reduced risk size has a pip value of half of that:
Pip value against the trend – $100 / 11.6 = $8.62
You see where this is going? Gee I hope so, it’s as fancy with maths as I can get.
Now for the reveal. I take 6 trades, 1 with the trend that gives up a 4:1 risk/reward, and 5 against the trend who get stopped out at their 10 pip stops. The key to remember is the difference in pip value for a trade with the trend vs one against it:
1 trade * 46 pips (cost of trade x 4) * $17.24 pip value = +$689.60 = +46 pips
5 trades * 11.6 pips * -$8.62 pip value = -$499.96 = -58 pips
Net result = +$189.64 (-12 pips)
I made money, yet lost pips. Pip counts don’t matter.
In the end, what matters is what you had to risk to get your reward. In the end what matters is you balance at the end of the week. In the end what matters is if you are still trading tomorrow.
My maths skills are debatable at times, please let me know of any errors in calculation in the comments below. ↩︎