Using 1:1 risk/reward in trading as a psychological edge | Forex Factory

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Using 1:1 risk/reward in trading as a psychological edge

  • #1
  • First Post: Dec 25, 2019 7:23am Dec 25, 2019 7:23am
A lot has been written and discussed about what’s the “proper” risk/reward ratio (RRR) in trading, its tightly-coupled nature with win-rate, and if this ratio is a goal by itself (commonly answered as NO), or only a quality metric to evaluate a potential deal (commonly answered as YES).

However, I want to share with you my perspective about this, a perspective I must admit I’ve never seen taken others, so I really wonder if that’s because it’s completely bullshit, or just that traders don’t think that way (and maybe they should).

My take on this is really simple. I’m not using the RRR as a money management tool. I’m using it as a psychological one to gain my edge. For me, using 1:1 actually means “be batter than a monkey”, or than a coin flip. I mean, if I enter trades by flipping a coin, buy or sell, and always set 1:1 RRR, expectancy should be zero (putting aside spread/swap for a moment). To get a better win rate, I just need a slight edge over the coin. Or the monkey. A tiny slight edge, and with 51% win rate with 1:1 RRR I’m profitable, right? OK, so I need a bit better edge to cover spread/swap. And yet, for me, waking each morning and think – “hey, you just need to be a bit better than a monkey. That’s it. Better than a monkey!!! No way I can’t do it…” – for me this one makes all the change.

So yes, maybe I’m setting TP far away from a natural support/resistant level, and maybe I’m missing a lot of potential. I don’t know. Maybe. On the other hand, I prefer keeping the 1:1 RRR to gain the psychological edge than to play with the RRR and start thinking questions like “Am I a good trader”…

I’d really like to get your thoughts and about this.
  • #2
  • Dec 25, 2019 7:00pm Dec 25, 2019 7:00pm
You're asking a million$ question. That is the first and biggest question when I started trading a long time ago. Now I've kinda reached my conclusion. 1:1 can be a great "strategy" to make profits.

Blackjack gamblers count cards in order to get an edge of 51-53% of winning advantage. I read several books about it and realized that kind of edge makes the holy grail.
  • #3
  • Dec 25, 2019 9:27pm Dec 25, 2019 9:27pm
Dear Yani av,

Monkeys really are amazing creatures, THIS one has been conditioned to remember locations and sequences of many numbers in seconds since something like 5 years old. No human can match it, even a guy that remembers order of deck of cards as written in the article. I am no expert on monkey, so what I had learned about them is they need to remember locations of fruit trees etc. in order to survive. Now is this a valuable skill in trading? Not really in my opinion as we have the history with a click of a button and do not need to remember as we can use indicators etc....

I had trouble understanding to which psychological edge you are talking about, it would be great if you can discuss it with some more detail

I think it is great identifying that you can target 51% (comm/ spread excl. ) with a 1:1 RRR to be profitable, I just have one other question;
Over what time period?

Why time? Because it takes time to make the trades and number of trades is something I consider to be important piece of a psychological edge.

I will share my perspective of what a psychological edge means to me;
It is the ability to stay logical, disciplined, manage risk, control emotions and follow ones planned trading strategy perfectly.

Now, getting back to your 51% example.
Risking $100 per trade, with knowing that you have a ~1% edge you make 200 trades and get this result below (red line, right scale):

Attached Image (click to enlarge)
Click to Enlarge Name: Screenshot1.png Size: 43 KB


Yup, a loss of -$200! After 200 trades, and the maximum drawdown for this period was -$1400...

Here is the part where I consider how to define a part of the psychological edge in my view.
The question the trader using that strategy would be thinking if they want to give up or continue to trade.

They can give up and walk away after that lost time, opportunity cost and -$200 OR they keep trading and take another 1800 trades. This larger amount of trades will allow the law of large numbers to kick in.

Here is the outcome that trader ended up with after taking the rest of the trades:
Attached Image (click to enlarge)
Click to Enlarge Name: Screenshot2.png Size: 36 KB


The result was a $5200 profit, and I circled the starting period of first 200 trades in yellow.

What can we learn from this?
That it could be very difficult to keep trading this system for some, even though we know theoretically it should be profitable in the long run as the example above. At one point, there was 8 losses in a row resulting in -$800... But it is a 51% accurate system and the probability of that occurring was 0.49*0.49*0.49......or (0.49^8) *100% = 0.33% chance Be mindful it can be as many as 14 losses in a row even as it is possible but not likely.

So, the psychological edge? Being aware of ones drawdown limits with a strategy so one can follow it long enough to be profitable.
As an example, say then that we cut the RRR from 1:1 to half at 0.5:1 ... Now as there is other effects from doing that we notice that our success probability has jumped from 51% to 70%! All we did is adjust to take profit faster, so we get more trades and they hit SL or TP faster.

What does this mean for our psychological edge now? Lets look at another example chart with 0.5 RRR @ ~70% accuracy:
Attached Image (click to enlarge)
Click to Enlarge Name: Screenshot3.png Size: 38 KB


We can see a real difference, the biggest lowest balance drawdown for this is only -$450... 3 times less than before. If you ask me, I would guess a trader will much more likely continue with this strategy. This in my view makes this an adjustment for a psychological edge, giving defense to the traders confidence in their system so they make enough trades to execute the edge.

Final thoughts:
There is a balance with everything, and so many things are linked.
Changing one thing, may indirectly affect others.
Take note of and understand the law of large numbers.
Even though time is not real, it is still a measure we humans have made up and follow.

Hope this helps and leads to some nice future learning points,
Kind Regards,
K
"Work hard, put in the effort, and follow your dreams..." -Me
  • #4
  • Dec 26, 2019 1:02am Dec 26, 2019 1:02am
Hi,
Tzamo's post well highlights a key point in all of this: that your ability, psychologically speaking, to keep on trading your system through statistically inevitable bad patches is a crucial consideration.

Any method of any R:R that contains a net positive expectation can be traded for profit but some are easier on our emotions than others. For example, I was once offered a system that had a full 5 year track record of excellent overall profitability. Problem was, the 5 years included 3 occasions suffering an 80% drawdown. How many of us can see 80% of the account disappear and keep going on regardless even one time? Not me for sure.

You have to find a method that you 100% believe in and that suits your personality, as both elements are essential in being able to trust the method and keep going through bad patches. What R:R your method contains has a bearing (along with a few other things) on the likely drawdown profile and you simply have to give proper weight and consideration to this.
  • #5
  • Edited 1:38am Dec 26, 2019 1:23am | Edited 1:38am
I think I understand what Tzamo and Oldtraderman say.

If you want to do 1:1 trading with a little drawback, the key is the winning rate. 51-55% is not good enough, because consecutive loss could be easily more than 10. A very few traders can endure such a big drawback, mentally speaking.

If you win 65% or more, you could keep trading with much less stress.

Having said the above, once you can win 65% or more, you would have a different kind of problem. That is, you could hardly keep 1:1 -- you get greedy and want to maximize the profit. Then, when you abandon the simplicity of 1:1 trading, the chances are that you start losing a lot, resulting in the winning rate less than 50%.

I've never seen anyone who could stick to the 1:1 trading all the way.

If you overcome this problem, you can have a "psychological edge" that this thread is talking about. :-)
  • #6
  • Dec 26, 2019 1:33am Dec 26, 2019 1:33am
Quoting yaniv_av
A lot has been written and discussed about what’s the “proper” risk/reward ratio (RRR) in trading, its tightly-coupled nature with win-rate, and if this ratio is a goal by itself (commonly answered as NO), or only a quality metric to evaluate a potential deal (commonly answered as YES). However, I want to share with you my perspective about this, a perspective I must admit I’ve never seen taken others, so I really wonder if that’s because it’s completely bullshit, or just that traders don’t think that way (and maybe they should). My take on this...
Hi, in my view stop thinking risk reward, you'll be successful. I'll attach some screen shots. Over the last 4 years, I've set a TP 3 times & that's for personal reasons not for any RRR reasons.

Good luck hope this helps.
Attached Image(s) (click to enlarge)
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Click to Enlarge Name: Screenshot_20191226-073112.jpg Size: 102 KB
Click to Enlarge Name: Screenshot_20191226-073046.jpg Size: 68 KB
J12
  • #7
  • Dec 26, 2019 1:39am Dec 26, 2019 1:39am
In my view it's a waste of time & stresses you out for no reason. Plays with your mind & your spirit. And on top of that it makes you doubt yourself.
J12
  • #8
  • Edited 4:24am Dec 26, 2019 2:46am | Edited 4:24am
Oh god… I’m on GMT-2 so I’ve just woke up and got all your great feedback. First, I really happy about this discussion – this is exactly the direction I wanted this thread to go. Discussing the mental implications and not tech analysis / math everyone always automatically sucked into.

I basically agree to almost anything you are describing my dear friends.

Tzamo – I made these simulations so many times in the past, and this is some of the reasons I made into my 1:1 conclusion. I can’t agree more to this one: “Changing one thing, may indirectly affect others”. I think that’s the core thing for me. I can’t play with so many things. Doing that, takes me out of focus and causes me a lot of stress and self-destructive questions. I realized I need to find one thing to play with. And for me, the 1:1 RR was the one that gives me confidence in my trading. I just can’t believe that after more than 20 years of trading here and there, reading so many books and articles, analyzing endless number of charts, using so many money management techniques and trading styles, and of course, doing so many mistakes along the path – I don’t believe I can’t beat a 50% coin flip. I just can’t accept this. and this is exactly what keeps me on trading my system through statistically inevitable bad patches.

Forexgogo & Oldtraderman – Of course, time & DD are important part of this mentality game. Now I have to admit, I have (much) better win-rate than 51% the thing is that I don’t need to think of that. I only need to think on my edge against a coin flip. Honestly, if I had a few Q’s of consecutive losses and major DD, I’m not sure how I would have dealt with it, mental speaking. The fact that I’m using 1:1, decrease the probability of big DD over most traders who are using 1:2/1:3/1:4 or higher RRR. And that keeps me in the game for long time.

J12 – I read your other thread so I think I understand your general approach. However, I feel that consecrating only on 1:1 RR trading, that’s exactly what makes me not doubting yourself, and keep me out of stress. I guess for you it’s focusing on profit & growth. That’s your goals, OK. But what is THE THING that gives you an edge to gain these goals? Everyone wants profit… what is leading you there? For me, it’s 1:1 RR, as I explained above. Using it, keeps me in the game, gives me clarity, and decreases my stress, and eventually leads me to me profitable. Well, I think that’s the thing LOL
  • #9
  • Dec 26, 2019 4:38am Dec 26, 2019 4:38am
Quoting yaniv_av
Honestly, if I had a few Q’s of consecutive losses and major DD, I’m not sure how I would have dealt with it, mental speaking. The fact that I’m using 1:1, decrease the probability of big DD over most traders who are using 1:2/1:3/1:4 or higher RRR. And that keeps me in the game for long time.
This is why I wrote "it's a million$ question." You seem to understand the beauty of the 1:1 trading.

It can be a great strategy that traders on FF don't care. You are the first one to touch on it as long as I know.

Now my question for you is, how do you make entries? must be more than coin flips. ;-)
  • #10
  • Dec 26, 2019 4:48am Dec 26, 2019 4:48am
Quoting yaniv_av
Oh god… I’m on GMT-2 so I’ve just woke up and got all your great feedback. First, I really happy about this discussion – this is exactly the direction I wanted this thread to go. Discussing the mental implications and not tech analysis / math everyone always automatically sucked into. I basically agree to almost anything you are describing my dear friends. Tzamo – I made these simulations so many times in the past, and this is some of the reasons I made into my 1:1 conclusion. I can’t agree more to this one: “Changing one thing, may indirectly affect...
What give me the edge is cutting out all the noise. Not thinking about things I have no control of. For me profit & growth always. If the theory of 1:1 RRR is working for you then you also have P&G
J12
  • #11
  • Dec 27, 2019 4:21am Dec 27, 2019 4:21am
Quoting Forexgogo
{quote} This is why I wrote "it's a million$ question." You seem to understand the beauty of the 1:1 trading. It can be a great strategy that traders on FF don't care. You are the first one to touch on it as long as I know. Now my question for you is, how do you make entries? must be more than coin flips. ;-)
well, that's exactly what I didn't want this thread to be - yet another trading techniques thread
anyway, nothing too excited I'm afraid. mainly price action patterns. like breaking S/R level, retesting, and continue the breakout. or breaking S/R level, and falling back. sometimes also turning points on bollinger bands. mainly using H4 charts.
  • #12
  • Dec 27, 2019 5:05am Dec 27, 2019 5:05am
Quoting yaniv_av
{quote} well, that's exactly what I didn't want this thread to be - yet another trading techniques thread anyway, nothing too excited I'm afraid. mainly price action patterns. like breaking S/R level, retesting, and continue the breakout. or breaking S/R level, and falling back. sometimes also turning points on bollinger bands. mainly using H4 charts.
Ok, I assume that you set SL/TP=1:1, but for every entry you put in different number of pips, according to the volatility. If so, how do you determine how far you set TP/SL? Do you consider TP first, then SL? Or otherwise?

In my case, I set SL/TP=1:1 with the same amount of pips for ALL ENTRIES. e.g, when I trade GBPJPY put in 25-pip every time. And I take positions according to confluence of Stoc's oscillator and EMA. I somehow keep the winning rate 65% or more, after good amount of practice.

Now do you see my "psychological edge"? That is, I really don't care how much I could've made profits -- the profit is fixed BEFORE the entry. I aim to win twice a day. That is it. This way my total earning is pretty stable.

I've been sharing this strategy on FF, but no one seems to be interested in. :-)
  • #13
  • Dec 27, 2019 6:40am Dec 27, 2019 6:40am
Quoting Forexgogo
{quote} Ok, I assume that you set SL/TP=1:1, but for every entry you put in different number of pips, according to the volatility. If so, how do you determine how far you set TP/SL? Do you consider TP first, then SL? Or otherwise? In my case, I set SL/TP=1:1 with the same amount of pips for ALL ENTRIES. e.g, when I trade GBPJPY put in 25-pip every time. And I take positions according to confluence of Stoc's oscillator and EMA. I somehow keep the winning rate 65% or more, after good amount of practice. Now do you see my "psychological edge"? That...
I'm using a similar method. I'm always setting SL first of course, most of the time below/above the last swing low/high (but not less than X pips, depends on the TF and volatility). TP is 1:1. and I'm setting a fixed amount of $ to set my position size. like 100$ SL/TP (that's much better money management method for systems of 1:1 which have low z-score). So same here, the profit or loss are known & fixed before the entry
  • #14
  • Dec 27, 2019 2:31pm Dec 27, 2019 2:31pm
Interesting topic
The answer should be "depends on your strategy"
Every strategy has a "sweet spot" where you are having the highest expectancy with the lowest max draw down.

In my studies I have found that it is extremely difficult to find reliable strategies that have 70% or more wining trades (without accumulating risk)
I have also found that the better the R:R the lower the success rate (of course) and the longer the stagnation periods. This also leads to less effective money management (if you use active MM not with constant lot size)
To conclude, for me is nonsense to make decisions based on gut feel(or what you are psychologically comfortable). Good systems are too rare so we can`t be too picky and waste your edge based on emotions.
Here you can check the stats for the systems that I am using http://financialmarkets.zone/automated-trading-systems/
  • #15
  • Dec 27, 2019 4:25pm Dec 27, 2019 4:25pm
Quoting Oldtraderman
Hi, Tzamo's post well highlights a key point in all of this: that your ability, psychologically speaking, to keep on trading your system through statistically inevitable bad patches is a crucial consideration. Any method of any R:R that contains a net positive expectation can be traded for profit but some are easier on our emotions than others. For example, I was once offered a system that had a full 5 year track record of excellent overall profitability. Problem was, the 5 years included 3 occasions suffering an 80% drawdown. How many of us can...
That's why I like daytrading, scalping it never goes out of style. Trading basically one system now over10 years. There would be no long term trades without it. Price pattern trades. Most traders want to multi task when trading. Good if ya get do it. Sleep and earn $$ LoL.
  • #16
  • Edited 11:22pm Dec 27, 2019 6:56pm | Edited 11:22pm
Quoting yaniv_av
{quote} TP is 1:1. and I'm setting a fixed amount of $ to set my position size. So same here, the profit or loss are known & fixed before the entry
Risking the same amount of money for every trade on "double-or-nothing" basis, which is the same approach as mine. However, your strategy is much more complicated than mine in terms that you take several ways of taking positions, such as "breaking S/R level, retesting, and continue the breakout. or breaking S/R level, and falling back. sometimes also turning points on bollinger bands."

I use only one way of taking positions, confluence of Stoc's oscillator and EMA, which is much simpler than your entry methods. I guess this simplicity gives a pretty solid winning rate regardless of the market condition (trending or ranging). And I believe that having a solid/stable winning rate is a crucial factor for the 1:1 trading.

Don't get me wrong -- I'm not judging your trading style. I'm just doing a theoretical discussion.

FMZ wrote: "The answer should be "depends on your strategy." I say, it should depend on your trading philosophy. Here is why.

How do you want profiting 1,000 pips in a month? 1,000 pips at once? or 100 pips x10? or 10 pips x100? or 5 pips x200? or you don't care fixed pips, rather you take pips as much as possible when you win?

I really want steady income/profit regardless of the market condition, so I decide to rake 10 pips x100 a month because it sounds more "can-be-done." Then I seek for strategy that can make it happen.

This is my philosophy in doing forex. Without it, I feel like I'm a chaotic casino, looking for bubble money.

Fmz also wrote: "I have also found that the better the R:R the lower the success rate (of course) and the longer the stagnation periods. This also leads to less effective money management (if you use active MM not with constant lot size)"

So, how do you overcome this problem/question? I say, the answer is not strategy, but philosophy that I discussed above -- the philosophy of how you make profit. Strategies come later to fulfill the philosophy....
  • #17
  • Dec 28, 2019 4:34am Dec 28, 2019 4:34am
Quoting dforant1
{quote} That's why I like daytrading, scalping it never goes out of style.
Hi,
One of the principal advantages of both daytrading and scalping is that you get a lot of goes compared to longer term strategies. This tends to make trading a simple numbers game where the law of large numbers can work to crystallise your edge, and keeps drawdowns comparatively brief - assuming, of course, you maintain discipline, consistency and good risk control throughout. Otherwise it tends just to hasten your decline into account wipeout.

Relating this to the main theme of this thread, shorter term trading does generally use strategies with lower R:R ratios because, if nothing else, trades have less time to grow to become huge R:R winners. You can, however, run strategies with 1:1 R:R + win rate only just over 50% and still be consistently profitable because of the volume of trades.

Even so, the higher you can push the win rate above 50% and/or the more you can improve the average R:R achieved above 1:1 then the shallower your drawdowns will be and the smoother equity curve you will have. Achieving this does greatly ease the psychological burden of trading as you will never find yourself too far underwater, and never for too long.

The logical endpoint of all this is that a 'holy grail' system would be one that:
- has a high win rate
- has a big R:R ratio
- gives you lots of goes

The fact that such systems are not abundant tells you it is rather difficult to achieve! Most of us have to work with a method that respectably achieves perhaps 2 out of 3 of these desirable traits and generate a profit with that. What balance of these traits your method has is ultimately largely down to your personal psyche and what style of method you feel comfortable trading with.
  • #18
  • Dec 28, 2019 4:47am Dec 28, 2019 4:47am
Love the simplicity of what you're saying. Ultimately I think each trader has to find the balance between RRR & win% they are most comfortable with (or least uncomfortable!) knowing full well that whatever we choose, we have to trade one thing for another.

e.g. going for low RRR means having to deal with the psychological difficulty of taking profits early on a trade that then carries on without us.
or going for high RRR means sitting through a large number of losers and the psychological difficulty of remaining confident in our method.

It's easy to look at an equity curve and think we could have stuck with our plan through the drawdowns, but doing so in real life is very very difficult.

Personally, I stick with a super-simple method of setting a TP order at 2R. I've had to learn to accept the discomfort of seeing trades carry on without me, as well as the discomfort of trades not quite reaching TP and reversing. But in return I get a much smoother equity curve and better mental health!
  • #19
  • Dec 29, 2019 8:56am Dec 29, 2019 8:56am
Quoting Fmz
Interesting topic The answer should be "depends on your strategy" Every strategy has a "sweet spot" where you are having the highest expectancy with the lowest max draw down. In my studies I have found that it is extremely difficult to find reliable strategies that have 70% or more wining trades (without accumulating risk) I have also found that the better the R:R the lower the success rate (of course) and the longer the stagnation periods. This also leads to less effective money management (if you use active MM not with constant lot size) To conclude,...
well, that's true if you develop a system and only then check it's KPI's, or reuse existing systems you find out there. I personally develope my systems by myself, and take my RRR preference into account when building the system, not after that
  • #20
  • Jan 2, 2020 8:14am Jan 2, 2020 8:14am
Yes, it really works and many traders get rid of emotional tension this way. "Strategy 1:1 Risk" helps to reduce the perception of risk, but you forgot about using leverage, which in turn increases the risk. The main thing that a trader should understand before taking leverage - is that it will trade on borrowed money. If the deal is successful, you can get many times more, but if it is negative, the losses will be measured in the same proportion. And the loan - it is the money you borrowed. You take broker's money, and should repay them. The problem is that due to their psychology, people perceive the leverage as real money. Because of this, traders often do reckless things. Initially, a trader doesn't perceive such money as a loan, and cause of this allows himself more aggressive and reckless transactions. However, if a deal goes wrong, traders begin to be afraid of losing money and again take reckless actions. So, if a trader has no confidence, it's better to trade without leverage.
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