How many pips do you need to make a million dollars?

When you're sitting around waiting for the market to do something a fun way to pass the time is calculating how many more pips you'll need to reach $1 million. Of course before there's any point in doing this you'll need a disciplined trading strategy that's been thoroughly tested and has at least a half-decent chance of earning you the necessary number of pips. Got that? Then let's proceed...

Let's say you're starting with $1000. First off, the only semi-realistic way I'm aware of to make a million from $1000 in forex is by pursuing a fixed fractional trade sizing strategy, which allocates more funds to each trade in proportion to increases in your account balance.

So you've got your $1000 and your fixed fractional strategy, and a trading system that makes you, oh, how about 10 pips per trade on average. (Any system that can do that consistently is a system worth keeping. Secret.) You decide you're going to start by trading 1 mini-lot, a sensible thing to do with an account of this size.

After your first 100 trades you've racked up $1000 in profits. Congratulations. Since your account size has just doubled, you can now double your trade size according to the fixed fractional technique, so you're now trading 2 mini-lots each time. Another 100 trades at 10 pips per trade on average, and you've doubled your account again to $4000. Getting the idea? Each time you make 1000 pips, you double your account size. So in the ideal world of your forex fantasies, your trading progress will look something like this:

$1000 + 1000 pips @ $1/pip = $2000
$2000 + 1000 pips @ $2/pip = $4000
$4000 + 1000 pips @ $4/pip = $8000
$8000 + 1000 pips @ $8/pip = $16,000
$16,000 + 1000 pips @ $16/pip = $32,000
$32,000 + 1000 pips @ $32/pip = $64,000
$64,000 + 1000 pips @ $64/pip = $128,000
$128,000 + 1000 pips @ $128/pip = $256,000
$256,000 + 1000 pips @ $256/pip = $512,000
$512,000 + 1000 pips @ $512/pip = $1,024,000 = jackpot!

Add up all those pips and it'll take 10,000 pips to get you to $1 million. Seems like a lot of pips, but if you can make a steady 50 pips a week you'll be there in about 4 years. Increase your risk substantially and double your trade sizes, and you'll need only 5000 pips to reach a million. But I wouldn't increase my trade sizes much more than that because each time you do you increase the risk of a severe drawdown wiping out your account. Above all you need to preserve enough of your capital through bad patches to keep on trading - this is a long-distance run, not a sprint.

Of course, thinking about this in theory and actually pulling it off are two vastly different things. You'll need a winning trading system, the discipline to put it into practice consistently, and the ability to withstand serious and inevitable drawdowns along the way. But it's still fun to think about, isn't it?

PS - feel free to correct any errors in my math or dumb assumptions I may have made here in the comments below.

Don't Be Afraid to Start Small

Happy 2007! As I head into this new year I've been thinking about how I first got into forex, which was only a year and a half ago, and what advice I might be able to pass on to someone who's put "learn forex" on their list of New Year's resolutions. And one of the first things that came to mind is something I think it's safe to say is on every trader's mind: money.

When I got started, one of the most intimidating things about the forex market for me was the amounts of money involved. Just about any forex tutorial you come across online mentions those trillions and trillions of dollars that flow through the market every day, and if you read enough forex articles and forum posts you'll invariably come across tales of massive bets made by big currency players. And if you read enough of this stuff it's not long before your little stake of a few hundred or a few thousand dollars starts to look pretty puny. It's not the greatest feeling being a very little fish in a very big pond. How are you ever going to turn your tiny forex fund into enough money to retire early, put your kids through college, or buy that solid gold house you've always wanted, as the case may be?

My reply to such monetary anxieties is simple: don't be afraid to start small. In the long-term progress of your forex career, how much you start with is certainly a contributing factor, but it's far, far, far from being the most important one. What's vastly more important is how you manage, allocate, and trade with those funds. Here's why:

• Someone with $500 and a robust, well tested trading system, a highly disciplined approach to trading, and a risk management strategy focused on capital preservation and sustainable levels of risk, can make a lot more in the long run than someone with $50,000 and none of these virtues.
  
  
• Familiarize yourself with fixed fractional strategies for allocating your trading funds. In forex, the potential for compounding your profits is incredible. This is not the 3% in your savings account compounded monthly; depending on your trading strategy, you could be compounding your profits daily or even a few times a day. Play around with some compounding formulas on your calculator, even with very low profit margins and a small starting balance, and the results will get your attention in a hurry.
  


• Leverage: your forex broker will extend you a certain amount of leverage that allows you to make trades with amounts of money several times larger than your actual account balance. So you have more power in the market than you think. But keep in mind this is a double-edged sword, and high levels of leverage enable you to take on high levels of risk. To paraphrase Star Wars, "Use the Force [leverage] wisely, young Jedi!"
  


• Starting small means you won't dig as deeply into your savings (or even worse, go into debt), and having a more modest sum at risk will give you a lot less to worry about as you find your footing as a forex trader. Worrying less means you're less likely to panic when things go wrong. And being less likely to panic means you'll make better trading decisions.
  
  
• Remember learning to swim? The shallow end was always the safest place to get your feet wet for the first time. The same goes with forex. It's much better to learn good trading habits with a small forex fund than make a huge deposit and go doggy-paddling into the deep end on your first day.
  
  
• Your funds are a trading tool, just like your charts and the indicators you choose to display on them. Your main focus should be on using them intelligently and consistently - not on how many there are, how cool they look, or how many monitors they're displayed on.
  

How do I know all this? Well, I started small myself, and knowing what I know now (which is not a lot, but it's not nothing, either) I'd definitely start that way again.

Happy New Year - hope yours is a prosperous one!

Taking on Excessive Risk

This seemed like a good topic for today because I've been taking on too much risk at certain points in my trading without really thinking about it - and I suspect that's how it happens to a lot of traders. My risk management mistake is failing to scale back my position after a loss if I decide to continue the trade in the same direction. This happened today as I decided to continue a long trade I started yesterday. Both trades went the wrong direction thanks to some good US CPI numbers, and according to a strict fixed fractional strategy I should have jettisoned a few mini-lots today to bring my position into the proper ratio with my reduced capital. But I didn't, ending up with a position, and a loss, that is significantly larger than it should be.

There are a few reasons I give myself for failing to scale back losing positions like this: (1) overconfidence that my system's accuracy will turn the loss around quickly and fix the problem (2) the fact that I hate spending money on spread costs, and I'd have to spend more to exit and then re-enter positions with a smaller lot size (3) concerns about sloppy execution and losing a few pips in the time it takes to exit and enter the trades. The last two reasons are somewhat valid, but the amounts I'd be saving are almost certainly smaller than what I'm losing by taking on too much risk.

In my experience, excessive risk tends to creep up on you like this when you're not paying attention, or paying attention to the wrong things, like that loss you really need to recoup in a hurry. Some common justifications for taking on too much risk that you might want to watch out for are:

• Just this once - kind of like that last drink or cigarette before you quit.
  
  
• Total impulse - you prevent yourself from thinking about it, you just leap without looking because forex is only interesting if it's a gamble.
  
  
• Good reasons for a bad idea - sure, saving on spread costs is a good idea, but not if you end up risking 25% more than you should.
  
  
• False sense of security - you set a very tight stop-loss and it keeps getting hit over and over again. In this case the thing that makes you feel safest in your trading is actually the biggest threat to your success.
  
  
• Boredom #1:I haven't analyzed my trading and I don't feel like it because it's boring, and therefore I have no idea what's too risky.
  
  
• Boredom #2: Trading with lower levels of risk is incredibly boring and way too much like my day job to be worthwhile.
  
  
• Starting with an unreasonable goal and reasoning backwards from it - I'm in a hurry to get rich and I can only make $1 million in 6 months if I take on this much risk.
  
  
• Pursuing a statistically valid but aggressive strategy like Martingale without the funds to back it up.
  
  
• Setting up an automated trading system but failing to monitor it closely and after a losing streak it ends up risking way too much.
  
  
• Misidentifying high risk events as low risk. For instance, trading on big news events can seem like a higher reward/lower risk scenario. All you do is see which way the trend is going and jump on it, right? But then there are the whipsaws, and the stop-hunting, and the various fake-outs the market likes to pull at these times, and what seemed low risk turns out to be quite risky after all.
  
  
• "Picking up nickels in front of a steamroller" - certain types of carry trading have been described this way. It's easy to focus on a reliable trickle of profits and be lulled into ignoring the underlying risks of your position. This is another example of misidentifying high risks as low risks.
  

Those are just a few of the ways this can turn into a very risky business very quickly. If you've got more to suggest, please post them in the comments...

Compounding Your Trading Profits: A Fixed Fractional Tutorial

I'm never sure if I'm making an obvious observation or not. But even if I am, this one comes with a cool chart. So here goes: if you're not compounding your trading profits by increasing trade sizes as your account balance grows, you should look into it. Using what's commonly termed a "fixed fractional" trade sizing system, a consistently successful trading strategy can become exponentially successful. Let's say you have a trading system that brings in $20 per trade when you first get started. Over the next 1000 trades, if you keep risking the same amounts as when you first started, you'll make $20,000. However, if you increase the amounts you're trading proportionally to the increase in your account balance, you'll make substantially more.

If you started with $1000, let's say you double that to $2000 after 50 trades. Using the fixed fractional system, you now double your trade sizes, and as a result are making $40/trade - and you're maintaining the same level of risk, since you're continuing to trade with a "fixed fraction" of your total funds. After another 50 trades you've doubled your account size again, to $4000. Time to double your trade size again - so now you're making $80 a trade.

You're now tapping into the power of compounding, and you don't even need to take on unreasonable or increasing levels of risk for it to work, since you're always risking the same percentage of your funds in every trade. That percentage is up to you, and should be one that allows you to weather a periodic (and inevitable) losing streak with your account intact. Keep in mind that during a losing streak you'd scale back your trade sizes as well - so if you end up with just your original $1000, you'll be back to $20 trades.

Here's a chart of what the difference between a compounding, fixed fractional strategy and a non-compounding strategy looks like over 1000 trades, assuming you're averaging $20 a trade to start with. Unlike the example above, which compounds every 50 days, this data is based on compounding after every single trade.


See that blue smudge at the bottom? That's the $20,000 non-compounded total. Sorry it's so hard to see...the scale is skewed a bit by the $1.4 million gains from compounding.

Again, this may be completely obvious to everyone, but isn't that graph fun to look at?

PS: Obviously exponential growth can't continue forever and if your account balance grows absolutely gigantic you won't be able to fill your orders or you'll be moving the market to much to profit when doing so. But I just file those issues under Good Problems to Have.

Related topic:
Forex Calculators & Converters