The amount of pips in Forex you make per trade, week or month is meaningless. Likewise, the percentage you make per trade, week or month is also meaningless.
That may sound harsh, so let me clarify…
You should know by now that your success as a trader is measured heavily by the risk to reward ratio you use, right? So to say you made 100 pips on a trade only tells half the story. What if your stop loss was 400 pips? Or worse, what if you didn’t use a stop loss?
The same is true with percentages. To say you made 8% last month sounds great, but it doesn’t tell the whole story. Did you make 8% while risking a combined 25%? Doesn’t sound so great, does it?
Where to Draw the Linedraw the lineCounting pips serves one purpose, and one purpose only – to define the placement of a stop loss order relative to a take profit order. So if you have a 50 pip stop loss, you know you need at least a 100 pip profit target to maintain a proper risk to reward ratio. That’s the extent of the value of a pip.
The same rule applies to percentages. A percentage gained is only as valuable as the percentage risked to achieve it. If you made 8% last month while risking 4%, great! Without knowing you had a combined risk of 4%, the 8% is meaningless.
Now that we’ve established the real value of pips and percentages, let’s discuss where they don’t belong.
Risking 2% Per Trade Doesn’t Cut ItThe conventional “wisdom” when it comes to risk management in the Forex market is to risk 2% of your account balance on each trade. I’m sure you’ve read this elsewhere in books or online. In theory it sounds fine, but in practice it’s 100% crazy.
Why, you ask? Because it only satisfies the logical side of your brain, not the emotional side. And we all know that it’s the emotional side of our brain that gets us into trouble as traders (and as human beings).
Before we move on, let me be clear that I’m not saying to go risk 10% of your account balance on one trade. I’m simply saying that an arbitrary percentage doesn’t cut it.
How Much Money is at Risk?Human beings are emotional creatures. We thrive on words like money, desire and risk. To illustrate this, which of the following phrases creates the most painful scenario in your mind?currency
Pips Lost
Percentage Lost
Money Lost
If you answered with anything other than “money lost”, you may want to have some tests done to make sure you’re human 😉
So if thinking in terms of money lost is what creates the most painful scenario, why are you defining and accepting risk as an arbitrary percentage such as 2%? You aren’t. You may be defining risk but you surely aren’t accepting it. This is because percentages and pips have no emotional value.
Quick Tip: Here’s a great Forex position size calculator. I’ve been using it for years and won’t enter a trade without it. The nice thing about it is that you can define your position size based on both percentage risked and money risked.
Why is this important? It all comes down to fully accepting the risk before putting on a trade. In other words, being 100% comfortable with losing all the money you’ve put at risk. That may sound like a simple and obvious statement, but it’s implications are huge if not completely understood.
Let’s assume you have a $10,000 account. You are doing your pre-trade analysis and determine that you’ll risk 2% on this trade. You use the calculator above and determine the position size, and put on the trade using a market order. The market moves against your position and you get stopped out for a loss. You get upset and immediately start looking for the next trade to win your money back. Sound familiar?
What if in the example above, you had said this out loud before placing the trade? (actually say this out loud as you read it)
I fully understand and accept that the market may not move in the desired direction. I have done my analysis and have determined the odds to be in my favor. Therefore, I am willing to risk $200 in order to see if my analysis is correct, as I believe it is. I fully accept the fact that I could lose the entire $200 on this trade.
Notice how you are not just defining the risk, you are accepting it as money that can be lost. You are convincing both sides of your brain (logical and emotional) that it’s okay to lose this money because it’s a necessary cost in order to see if your analysis is correct. It’s the cost of doing business.
The #1 cause for emotional trading comes from not fully accepting that all money risked can be lost on any given trade. It doesn’t matter how good the setup looks, there is always risk. If more traders went about their business this way, there would be a lot less emotion floating around the Forex market.
If I had to sum up this entire article, I would say that in order to be a consistent trader you need to not only define your risk, you need to accept it. And you can’t fully accept the risk until you’ve identified it as something the emotional side of your brain can relate to; and that’s money!
