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 What most traders or signal services do not publish is how much money value each pip has so there can never be made a real conclusion about how much money a trader has won or lost in a trade or during a time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.