I have received a good question from one of the readers of this blog regarding the link below pips gain versus percentage growth. Please spend sometime to read through this blog as it will be beneficial for you as a trader.
So does gaining more pips from a trade means higher percentage growth for your account? I bet most of you must have answered YES for the above question. That is only when you enter the same amount of lot per trade and your stop loss is the same for each trade.
However trader do not enter same number of lots per trade every month as their account size changes due to profits or losses from the previous month.
You have the habit of risking 5% of your account per trade and you have $5,000 in your account at the start of the month. Let says that your strategy has a risk reward of 1:2 per trade.
This means that you will risk $250 for each trade taken for the entire month. Now that you see a trading opportunity and decided to enter a SHORT trade and you are going to place your stop loss is going to be set at 25 pips and take profit at 50 pips.
Since you are willing to risk $250 per trade which means that you are willing to lose $250 for a trade if it goes against you, you will be entering 1 lot for the trade. If the trade turns out to be a winning trade with 50 pips profits, you will be making $500 for that trade which is 10% growth of your account.
Now that you have seen another trading opportunity and you are going to place the stop loss at 35 pips and take profit at 70 pips, this means that you will be entering 0.714 lot for that trade as the amount you are risking is still $250 per trade.
If the trade turns out to be a winning trade with 70 pips profits, you will still be making 70 x 7.14 = $500 for that trade. This also makes up to 10% growth of your account.
From the above example, can you see that you are actually making the same amount of profits even if the trade is 50 or 70 pips profits.
Therefore it does not means that gaining more pips equate to more percentage growth to your account. It has to go in line with the percentage risk per trade as well as the amount of stop loss and target profits per trade.
In fact, if you take a close look at the 2 trades above, I will prefer the trades with 50 pips target profits as it is much easier to hit that amount as compared to the 70 pips one since both of them yield the same amount of profits.
That is why all the strategies taught in my Forex Street University course has a fix stop loss and fix target profits. These stop loss and target profits has been fixed based on years of trading to give the best winning percentage for each strategy.
When you set the stop loss too tight, you will run the risk of getting more trades stopped out but when you set the stop loss to loose, the price has to travel more to hit your target profit to generate the same amount of growth. Therefore as a trader, you have to set an optimum balance between winning percentage and where is the best place to place the stop loss and target profits.
For those of you who are planning to formulate your own strategy, you should do a back test to check the winning percentage for each type of stop loss.
I hope that you guys enjoy this article and do feel free to give your comments below.