Why PIPS are Almost Irrelevant for Measuring Forex Trading Performance?

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This is a post by Neil Refield

When forex traders or companies want to tell other traders or people who might be interested in their trading about their performance they will often show them the number of pips made in a trade or in a given amount of time. Which is not bad at all but not enough information to say if a trader is consistently profitable. A pip in the forex world is commonly known as a point a currency pair moves either up or down. For example if the EURUSD jumps from 1.3800 to 1.3801 it has moved exactly up by one pip. What most traders or signal services do not publish is how much money value each pip has so there can never be made a real conclusion about how much money a trader has won or lost in a trade or during a time period with pips as the only performance information.

Pips are a perfect tool to measure the size of a movement a currency pair made or the size of a range the price is moving in. But when it comes to the performance and creating a statement about how a forex trader is doing at the markets pips can only be secondary information. Nobody can tell how much money value a pip had. That is why it is so important to consider trading performance sheets based only on pips as not reliable at all.

What kind of information do we need to measure forex trading performance?

Lets say a trader claims that he has made 500 pips profit in a month. To know how much profit he made in money we need some more information. What are the 500 pips worth in money and how much is that related to the capital the trader puts at risk in his broker account? To make it easy let us consider the following example. The trader uses USD based currency pairs only, starts the month with a trading capital of $10,000 and every position he takes has a lot size of 0.2 lots so the value of one pip is exactly $2.00. This way his profit of 500 pips would be worth $1,000 equal to 10.0 % return on his invested trading capital. With this data it is a lot easier to evaluate a traders performance.

Lets take a closer look at a little bit more complex example. A trader starting with a $10,000 account made a profit of only 150 pips after a month. But these 150 pips are equal to 15.0 % ($1,500) return on investment. How can that be? One unusual way would be that the trader took one position with a full lot order size and closed it at 150 pips profit so he would end up in $1,500 profit for this trade and then stops trading for the rest of the month. The more common way is that the trader had plenty of winning and losing trades during the month. The reason the trader can make such a reasonable amount of profit (15.0 % ROI) with such a small amount of pips gained is that the trader adjusts his position size with every trade to keep the risk he takes at the same amount.

For example one trade has a target of 200 pips (4.0 %) and a stop loss of 100 pips which are equal to 2.0 % ($200) of risk based on traders account balance of $10,000. He takes that position at a lot size of 0.2 lots to make sure he risks exactly 2.0 % of his trading capital. As this trade ended as a loser he takes the 100 pips loss and moves on to the next trade. This one has a much smaller stop loss of 25 (2.0 %) pips and a target of 50 (4.0 %) pips. For that reason he has to adjust his position size up to 0.8 lots to have the exact same amount of risk and reward ratio as with the previous trade. As this trade is a winner and hits the target he has made an overall profit. So lets have a look at the result. The trader had one losing trade with -2.00 % and one winning trade with 4.0 %. So he gained a total profit of +2.0 % based on his capital with 50 pips in loss! at the same time. That is why it is no problem to gain a decent amount of profit in money and ROI in a period of time while gaining no pips at all.

This unequal results can and should happen because it is essential to limit risk with every trade and there is no other way doing this than adjusting position size based on a proper stop loss. When you look at the performance of other traders or forex signal providers please always pay attention at the applied money management and the percentage of return on investment they won/loss based on the trading capital they put at risk. This is an easy way you can tell if a trader or forex signal service provides reliable information.

Neil Refield is the head of customer service at the forex signal service German Trading Group which is one of the few signal providers that try its best to provide full transparency by giving clients and interested people as much information as possible about their trading. GTG is a group of traders operating in forex business for more than five years and gone public to offer their trading to interested followers in September 2010.

Comments

I think that you have rather missed the point (sorry, no pun intended). The number of Pips gained or lost in a given period is more useful than someone saying “make $237,594 this month”, because it all depends on your starting equity, if you had $1,000,000 at the start of the month, the target figure could well be achieved, but if you only have $500 in your account, you have no chance at all. The profit you make is proportional to the pips gained and your starting capital, and only you know the capital, so comparisons between different systems or robots can only be drawn on the pips gained. Regards, Iain

I agree that the profit in $ does not say anything when not knowing the starting equity. But what i wanted to say with my post is that a number in % is more reliable then a number of pips made in a given period of time.

If somebody only say how many pips he made you do not know how much value these pips had and you do not know his return on investment.

However, if you just look at percent, this does not guarantee your success by following a trader…

The reason pips are oft quoted is because they allow you to calculate the return on a level stake.

Ie, each trade is worth x% of bankroll (or risk). Depedning on YOUR captial, you can decide how much YOU could have won.

I think it could have better been explained to look at it with a whole amount of data, and not just look at not looking at pips, and only looking at percent return. After all, what is right for you may not be right for me, so looking at only percentage return would give a false account of what I would expect…

I like the idea of your article though…! :)

Thank you for commenting on my post.

When you use pips only to measure the profit you assume that you are using level stakes as you say in your example.

But for most trading strategies the stop loss size has to be flexible because it is very important that one uses a proper stop loss placed below a support or above a resistance level.

If you want the stop loss size to be flexible and the risk always the same with every position you take the lot size is the only parameter that can be adjusted to keep the risk at the same level, for example 2%.

If somebody trades like this (what i always recommend) the amount of pips made does not say anything about the return on investment made in a given time period. If you use always the same lot size because you either always have the same stop loss level or risk different percentage of your trading capital with every trade pips always have the same value. If the have the same value in every trade in a given time period they are reliable for measuring the performance.

My statement is based on a flexible stop loss in combination with a fixed amount of risk of the trading capital with every trade.

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