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Pips - Are they really relevant?

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  • Pips - Are they really relevant?

    In this thread I am going to talk about "pips" and how in most cases, it can be an irrelevant variable in gauging ones performance.





    WHAT ARE PIPS?

    First off, "PIP" stands for Point In Percentage. In all pairs involving the Japanese Yen (JPY), a PIP is the 1/100th place - 2 places to the right of the decimal. In all other currency pairs, a pip is the 1/10,000th place - 4 places to the right of the decimal.

    Anything smaller than a PIP is known as a "PIPETTE". This is 1/10th of a PIP. "Pipettes" was introduced by major retail brokers in the early to mid 2000's. They're fractional pips that merely provide the trader more precise pricing. Some retail brokers today however, still display their quotes to the 4th decimal place.


    THE COMMON MISCONCEPTION OF PIPS

    You will find a lot of websites and traders mention how many "PIPS they bagged today or this month". In most cases - and frankly put - this can be very misleading as most novice traders perceive this as a fair measurement of ones proficiency.

    A PIP is merely a fractional change in price and has literally no direct relationship to the given trader unless we consider a few factors first.

    PIPS are only important once you determine what value the average PIP was relative to the trader at hand and strategy adopted.


    WHAT IS THE PIP VALUE - HOW DO WE FIGURE THIS OUT?

    First off, the exchange price represents how much of the quote currency is needed for you to get one unit of the base currency. Lets look at an example to make this crystal clear:

    GBP|USD current exchange price: 1.61250

    The Base currency is GBP. The quoted currency is USD. Assuming your broker allowed you to trade just 1 unit, in this example the Base would be GBP 1, and the quote was USD 1.6125. Meaning 1 would get you $1.61

    As we all know, no broker allows you to trade that small (fractions of a penny!).

    Right, now armed with these basics, we now want to find out what each PIP value is. That's to say, placing a usual sized trade with your broker, how much (monetary) is one PIP move in the exchange price on the pair in question?

    This is the basic formula to work out what each PIP is worth in the "Term Currency"(i.e. not the traders denominated trading currency):
    • ( PIP / Exchange Price ) x Lot Size (Units) = Value Per PIP

    So placing a 0.10 (10,000 units) on the price we just looked at on GBP|USD looks like this:
    • ( 0.0001 / 1.61250 ) x 10,000 = $0.62(term currency - not denominated trading currency)

    Pretty simple stuff! Let's look at some hypothetical traders so that we can put this into practice and see whether PIPS is really a standardized way in determining a traders profitability...



    HYPOTHETICAL TRADERS (keeping this simple!):

    Trader 1

    Sally only trades the EURUSD. She only ever places a 0.10 lot per trade (10,000 units). She has a 1,000 GBP denominated trading account. She uses hard stops of 20 PIPS but sometimes intervenes to cut her losses sooner.

    Today Sally's closed trades look like this:

    EURUSD - Buy: +23 PIPS
    EURUSD - Sell: -17 PIPS
    EURUSD - Sell: -20 PIPS


    Sally's Total PIPS: -14 PIPS

    As we know already, Sally uses fixed lots. Therefore, the value per PIP is easy for us to figure out:

    ( 0.0001 / EURUSD (1.27450) ) x 10,000) = 0.78

    So when Sally's places a 0.10 trade, each PIP move (greater than the spread) either for or against her will equate to €0.78. However, we want to know what each PIP is worth in Sally's trading currency (GBP).

    All we do is take the €0.78 x EURGBP (0.78916)= 0.61 - Pip value per 10,000 units. Now we can see what her trades looked like in her denominated trading currency:

    EURUSD - Buy: +23 PIPS x 0.61 = +14.03 Profit
    EURUSD - Sell: -17 PIPS x 0.61 = -10.37 Loss
    EURUSD - Sell: -20 PIPS x 0.61 = -12.20 Profit


    Sally's Total Loss: -8.54 or -0.85% on her initial 1,000 GBP trading balance.

    Therefore, we now know that when Sally tells us how many PIPS she has made, this does in-fact equate into a fair means of evaluating her profitability as each PIP is worth the same under the given circumstances.



    Trader 2

    James trades the EURUSD, GBPUSD and AUDJPY. The lot size he places is based upon a percentage of his current trading balance, relative to the stop distance in PIPS. He always risks 1.5% of his closed account balance on any-one trade setup. He has a $5,000 USD denominated trading account. He also has rules to only trade if there is a 1:1 risk:reward ratio as a minimum.

    Today James' closed trades look like this:

    EURGBP - Buy: +65 PIPS
    GBPUSD - Sell: +40 PIPS
    AUDJPY - Sell: -190 PIPS


    James' Total PIPS: -80 PIPS

    James finished the day down on PIPS. However, in monetary terms he is in fact up in his trading account. The reason why is because James treats every pair exactly the same with regards to his risk profile. Just before he placed the 3 trades, he did the following calculations first:

    Current Trade Balance: $5,000 USD * 1.5%(risk) = $75.00 USD(risk)

    Trade 1 EURGBP: James strategically wants to place the stop loss 45 PIPS away from his entry price. He then does the following calculations to figure out what lot size he should be using to entertain his risk profile of 1.5%:
    1. 45 PIPS / $75 = $1.66 per PIP
    2. What is PIP value per 1,000 units (0.01) on EURGBP? = ( 0.0001 / EURGBP 0.79040 ) x 1,000 = €0.12(term currency)
    3. He then wants to know what each PIP is worth in his own trading currency: €0.12 x EURUSD (1.27400) = $0.16
    4. Revisit point 1 above^, take $1.66 and divide by $0.16 = 10.3 - rounded down is 10 = 10,000 units or 0.10 lots.


    Therefore, James traded the EURGBP with a 0.10 lot size. He made on the trade +45 PIPS, which is a monetary gain of: +$72(rounded in deposit currency)

    Using the following principles above, each trade James places has the same monetary risk, relative to the closing balance. PIPs are completely irrelevant as he entertains his risk profile through dynamic lot sizing. Further more, he is only concerned with risk:reward ratios. So here is what James' account balance looked like at the end of the day:

    EURGBP - Buy: +45 PIPS = +$72.00(approx. example)
    GBPUSD - Sell: +40 PIPS = +$72.00(approx. example)
    AUDJPY - Sell: -190 PIPS = -$72.00(approx. example)

    James' Total PIPS: -80 PIPS

    James' Total PROFIT: $72.00(give or take some) or +1.44% gain on his initial $5,000 USD trading balance.




    CONCLUSION

    As you can see both traders, trade in very different ways. Sally likes to use fixed lots and PIP stops/targets. Whereas James strategically places his stops in the trades where he aims for at least a 1:1 (R:R) ratio. James is never concerned about how many PIPS he has or hasn't made because each trade can vary in stop and target distances from the entry price. The thing to remember is, the lot size he uses is always relative to the risk profile (%) of his closed account balance making PIPs completely redundant.

    Hopefully this has helped some people realise how PIPs really is, in most cases, a non-standardized way in verifying ones proficiency in trading. A lot of so called "professional" traders focus on their PIP numbers because unfortunately they realise that the general novice retail trader thinks they're all made equal. Sometimes certain websites can be incredibly misleading when they talk about the PIP numbers they have bagged.

    In a nut-shell, that is why some traders can have 1,000's of PIPs gained and then take a mere 100/s PIP loss that wipes out a huge chunk (%) of their account balance.

    "R Multiples" are the best and most standardized way in gauging what someone has risked for the reward they have made. This fixes the issue of having to calculate what each PIP was worth (as an observer) and also allows "you" (as the trader) to see what you're risking relative to the reward, as a ratio.

    More on this in future threads for those of you who are interested though


    **For those of you who invested your time in reading this, then I hope you can take away something of value. Any questions or feedback, please feel free to fire away below
    -"An economist is an expert who will know tomorrow why the things he predicted yesterday didn't happen today"-

    Follow me on Quora for Q&A on Forex: https://www.quora.com/profile/Dominic-Gilbert-2

  • #2
    Nice work, Dom. These posts (which could be called Debunking Forex Myths) should be collected into a separate educational section of the site, otherwise they will be lost.

    Comment


    • #3
      I think James' total profit was $72
      This topic really grinds my gears. So many times I've tried to explain exactly what you just said yet people still refuse to accept that pips are meaningless.

      Same as if a trader opens a trade and closes it in profit in 2 partial trades gets more pips than if they had've closed it all at once. Hopefully people start to accept it after such a detailed post!

      Comment


      • #4
        PIPs can indeed equate to nothing, but as outlined, this is depending on the trader in question.

        The issue you raise in connection to partial closing is a good one. This too can further diminish the point in PIPS...

        Glad you liked it.
        -"An economist is an expert who will know tomorrow why the things he predicted yesterday didn't happen today"-

        Follow me on Quora for Q&A on Forex: https://www.quora.com/profile/Dominic-Gilbert-2

        Comment


        • #5
          Originally posted by Dom View Post
          James' total profit was greater than $72. It was approx. double this (I do not know exactly as this was merely for illustrative purposes and are completely hypothetical. None the less, the formula's are correct and transferable.)

          PIPs can indeed equate to nothing, but as outlined, this is depending on the trader in question.

          The issue you raise in connection to partial closing is a good one. This too can further diminish the point in PIPS...

          Glad you liked it.
          In the example you provide James makes $72 + $72 - $72 = 72 or am I going crazy?

          Comment


          • #6
            Originally posted by pearcey2 View Post
            In the example you provide James makes $72 + $72 - $72 = 72 or am I going crazy?
            You are absolutely correct. My mistake. I made some alterations to my hypothetical traders and forgot to amend the results appropriately.

            Good spot, thank you.
            -"An economist is an expert who will know tomorrow why the things he predicted yesterday didn't happen today"-

            Follow me on Quora for Q&A on Forex: https://www.quora.com/profile/Dominic-Gilbert-2

            Comment


            • #7
              I totally agree. Pips are meaningless.

              Vendors use them for marketing (Zulutrade), however it's impossible to make an accurate assessment of a system looking at pips alone.

              You can't buy dinner with pips.
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              Comment


              • #8
                From what I know, they lay it out as a percentage based instead of profit, which makes it confusing, especially for new users.

                Comment


                • #9
                  Hello, I also use this term in my trading targets! Like, right now my daily trading target is 60 pips weekly target: 300 pips and monthly target is: 1200 pips! In addition, I have chosen my trading targets in order to my demo trading performance! If I get my monthly target consistently for next six months then should increase it!

                  Comment


                  • #10
                    This is spot on. Traders should be talking about % gains not pips as each pip value is different. One thing to also consider is SHARPE ratio which is risk adjusted profit factor you could say. Pros and hedge funds talk about a funds sharpe ratio not pips. Great post!!

                    Sent from my SM-N920I using Tapatalk

                    Comment


                    • #11
                      One of the most informative metrics is R-Multiples, as defined by Van Tharp. http://www.vantharp.com/tharp-concep...-multiples.asp

                      It measures a trade outcomes as a multiple of the initial risk, independent of money management. Example: 2R means the trade returned double the amount that was initially at risk.

                      Percentage return tells you about the traders money management. A winning trade of 2R could return any percentage, depending on the position size.

                      Comment

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