DislikedThe subject of 3:1 Reward to Risk Ratio came up in another thread and I decided to look into it. Personally, setting an arbitrary number based on when you decided to enter a trade is a weird notion to me. When you decide to enter, you are not only making a decision to enter, you are also deciding the time frame of your entry (With it's own issues like one TF says buy and another says sell), as well as the exit directions and the extent of which on either side. It is a stock market rule that seems to have found it's way to FX trading. It goes with...Ignored
He does eventually mention, but RRR goes hand in hand with % success of trade outcome. This should be the very first point....
If we think logically, the further our potential target, the more that can happen in between and the less likely it will hit.
Alternatively, the closer the target, the more likely it will get hit before ones stop.
Next point he fails to mention from the brief read I had done is;
The R (risk) does NOT have to be a fixed value. It can be variable based on atr, some distance, heck even a parabolic SAR. A trader can use R multiples when trading. However, if they do not have a plan behind their trading, one may assume the are trading randomly and will get a random result. That is where that % success comes in.
So where the heck would this % success come from?
It would come from a trading approach, well that is my view anyways. Most common with rule based systematic systems, one knows the % chance their trade will result in a profit and how much, while also what % chance it result in a loss and how much. The R multiple will most likely be already built into it.
Something to note, break even or trailing stops; so anything that causes ones systematic trades to either not hit the target or the stop loss (1 outcome out of 2) is like another new trade with different % probabilities associated with them. Many traders fail to understand this and unaware how this skews their rule based system. So instead of 2 outcomes, one may have 3,4+ outcomes and then wonder why they are not profitable in the long run with their X:1 RRR system.
Final points: Have a look at what might be a typical % success rate (% win). For 1:1 RRR, there may be some 65% win-rate systems, 2:1 RRR; now looking at 45%-55% win rate. Take it to 3:1 RRR, typical win rate may be around ~35%. These are average expected values of profitable strategies, based on my understanding and may be different. Anyways, I see the average as just over break even (+ some wiggle room) needed for the strategy to be profitable long term. See this image for the required % win rate B/E point of the system:
Attached Image
Final final point lol; One can combine profit taking strategies. Eg. Take 50% profit @ 1:1 RRR and leave the rest to go for either B/E or hit RRR: 3:1. Maybe the end outcome may end up close to 2:1 RRR, it may also smooth the equity curve a little. There is a gentleman doing this apparently, using a BB bands strategy, goes by the name of Etienne Crete I think. Unlike Jarrod, Etienne describes the strategy well from what I remember. Perhaps it could make good example for you to try investigate RRR with.
Bonus point ^_^ ; One can think in terms of Reward to Risk or RISK to reward. The risk is the more important one, well to me anyways. But our brains are funny things and thinking in terms of risk first could help in the long run by enforcing what we think about most
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