Investors love to talk in percentages. The Dow is up 25% this year, up 200% this decade. This stock is a ten bagger. Blah, blah, blah. Traders — if they want to be successful — should disabuse themselves of that notion as soon as possible and talk in terms of points instead.
Investing is the art of selecting assets and watching them grow (or in case of shorting watching them wither). So it makes perfect sense that investors should think about their performance in percentage terms. Trading on the other hand, is simply the skill of predicting price.
Trading, therefore, is the process of extracting points from price regardless of whether the asset moves up or down. I was reminded of that fact yesterday as I was listening to my favorite trading podcast — Chat with Traders. The host was interviewing a very active, successful equity trader and the guy invariably recounted every one of his trading stories in term of points rather than percentages. In short, he viewed his job as making points.
In FX we often talk of trades in terms of pips — which simply our industry slang for points — but few traders think about their whole trading business explicitly in those terms, Here is why we should. Looking at your trades in terms of points creates just the right amount of emotional distance to help avoid the worst psychological mistakes — the most common of which is pulling your stop.
Pulling your stop is like masturbation — everyone does it but no one wants to talk about it. But unlike the former, the latter is actually very bad for you both psychologically and financially. The primary reason that we all pull our stops is that we think of trading in terms of money and hate to lose it when the trade goes the wrong way. Once we’ve made that first poor choice the cycle of justifications takes over and we basically spend all our time watching a 5-minute trade turn into a multi-week nightmare that inevitably ends in a large money loss.
But no matter how matter how many times we tell ourselves we’ll never do it again — we will. Always. That’s why to change that behavior we need to reorient our thinking towards points. Points provide the proper metaphor to help abstract our emotional attachment to money. Points are like bricks. You use them to slowly build the foundation of your wealth. Sometimes bricks are chipped. Sometimes they need to be demolished and laid again, but as long as you are focusing on making bricks you are going to be much more tolerant of an occasional broken piece and will not try to build a structure with faulty pieces.
