Written by britt maras
Thursday, July 9th, 2009
Britt Maras shares his view on Risk Management and Pro Pip Talk
In today’s market environment risk management is even more important than at any time in history. All of us get bombarded with the new bust-out robot or service which blows the doors out. They read fascinating blogs about how many hundreds of pips were booked in just a few hours and how last quarter thousands of pips were earned with some top-secret forex robot program.
Just the facts Mam! How many currency pairs can a single trader carry open at any one point when following professional risk management rules? One? Three? Five?
They can trade as many as they want and open as many positions as they want as long as they follow typically respected professional ratios like never exposing more than 3% – 5% of your equity in any single/total risk event. That said, where does that leave you?
I was acquainted with a fellow who would send a message and say I just made 1500 pips last week. I’d laugh and say “Oh really, I must have missed that trade.” He’d say, “It was right in front of your eyes stupid!” Okay. Then I’d ask him how many “pips per lot did you make per trade entry/exit/pair”….. He’d say huh? I said again, “how many pips per lot did you make and what pair was it on”?
Of course the fun was just starting….. Then I’d get the earful again from him about how I should expand my horizons and trade more than just say, the eur/usd or the gbp/usd. When he’d get to that, I’d interrupt and ask him, “Should I trade them both at one time?” He’d exclaim, “huh”?
Then I would ask him “how many dog’s are in the lineup at a particular dog track race?” Then of course he’d say “okay Maras, enough already”……..
Is anybody catching on just yet? Let me explain:
If the U.S. Dollar is rising, that can be seen in a few different pairings. If the Sterling is rising, that too can be seen and of course if the Euro is rising – certainly that can be seen in different pairs. Each sovereign currency has its primary relationship to the Dollar then of course it has its own cross pairs. One note on cross pairs, in my opinion, they could be riskier unless you have the “delta” of sovereign interest rates matched in an extremely skewed ratio. For instance, when the Bank of England had a benchmark rate at 5.00 and the Bank of Japan had a benchmark rate at .50 – then indeed the cross currency had a delta worth risking. As seen lately in the FCM’s ‘rollover interest’, now down to pennies, one can clearly see there is not much delta in any pair!
In today’s environment, cross trading might be a greater risk than trading the base pair against the Dollar. So, now back to my friend……
He was the king of trading the Dollar in 4 different places at once……….Get that, eh? He was a real rocket scientist! I’d ask him…….”If you go to the dog track and you have 4 dogs with basically the same odds, will you bet on all four?” (This is when it got fun…)
He’d say, “Well, sure, if I like them all!” (LOL……me laughing, stop already, my tummy hurts!)
Then, I’d ask him, “well, how do you decide how much to put on each one if the odds are pretty much the same (the Dollar will rise or fall, basically) and how much are you willing to bet?”
Then, that’s when he’d say….”Well Maras, obviously I can only bet so much and if I want to bet all 13 races I have to calculate how much I need for the night”……..
Okay folks, back to the point!
The U.S. Dollar makes the world go’round. It is best seen and traded with unanimous popularity in the eur/usd pairing due to daily majority of transaction in the market: Usually near half of the daily market. Surely I want to trade the pair that is likely to gather the most participation versus trading a pair that might only gather 5% of today’s market participation. The more, the merrier! The fewer players in the crowd the deeper the chance to get hit!
So, let’s get back to pip counts and the reality and see just how many pips per lot can be made trading 3-5% margin of equity, per event, per entry, per currency in any one day or month.
In my example, I am going to use one pair, the eur/usd and since my Trade Alert call profile is about 2.3:1 (profit to loss) and better, and since my average stop loss is under 30 pips and my average loss of equity when hit is usually 2.5% or less of equity; let’s take a $5,000.00 account for example:
I would consider trading 3-5 mini lots per ANY SINGLE TRADE event as I cannot possibly bet on more than ONE dog at once if I am going to cap my margin at 5% with 5 lots on the eur/usd.
Now, let’s say the trade earns 50 pips profit on 5 mini lots, which equals $250.00. My gain in terms of pip count is 50 pips per lot profit, NOT 250 pips!
Let’s get back to my old acquaintance, whom of course is broke now and left Forex about a year ago. He much rather does one of two things: He would enjoy making sure he could nail down 750 pips earning just 50 pips on the trade BUT, trading all 3 currencies
(3 currencies X $250.00 earned = $750.00 mini PIPS profit)…. Huh?
Yes, you see….. He had a choice to make. Does he run 5 mini lots on each of three currencies (15% margin against equity – a REAL black-eye NO-NO) or does he run just 2 mini lots on all three for about the proper exposure I described above?
In either case, the pips profit IS STILL only 50 pips per lot! If he traded all three and capped at 5% margin, then he STILL only made 50 pips per lot and he still only made $250.00. But no…..for some….to them that means they made 150 pips because they did three currencies (50 pips per currency) BUT MAY NOT acknowledge they RAN just 1.5% per trade versus 5% on one trade!! Get it now?
If someone claims they made 300 pips but had to run 1.5% margin on two currencies instead of 3% margin on one currency and they each moved the same amount, the reality is the net profit in dollars is still the same but talking about making 300 pips sounds a heck of a lot better than making JUST 150 pips!!
How many candy apples can you eat at the same time?
You can make the same $250.00 on one dog versus three dogs or you can triple your exposure and risk triple and win triple BUT that is absolutely POOR and undesirable RISK! The point is, ON the event itself with professional management standards, trading the dollar, there was ONLY 50 pips gained on the move, NOT 150 because you traded three pairs.
The next time you make a decision about entertaining the results of any robot signal service ask yourself a few things: Is the service risk balanced or is the service reporting that they traded more than one pair on mostly similar events for a total gross pip count that is really no different than trading one pair with the same level of risk BUT not split up over 5 events. Inflation is SURELY not a good thing, in any business! An overinflated tire usually bursts, or goes flat. Keep kicking the tires – but kick ‘em in the right place!!
Lastly — we at FTD focus on risk management amongst the different style of traders in house here. Some of us may have HUGE pip counts and some smaller but the net gains may be similar when the trade events might be relative. My particular expertise is with intra-session trades that yield solid pips per lot on single maturity events that focus on one event, one entry and an exit. Thanks for being here!
Check out our free Forex Training Course here
Britt Maras — Senior Currency Strategist
