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What Is a 3:1 Reward to Risk Ratio?

  • #21
  • Edited 8:43am Sep 11, 2020 8:27am | Edited 8:43am
Quoting OutThere
The 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...
Hey mate, I see you stumbled upon Jarrod and his articles on risk to reward ratio (RRR). There are some inconsistencies in the articles, especially things like exaggerated examples and heavy bias towards timed exits later on in the 2:1 article. Take his stuff with a grain of salt...especially if you can't replicate his findings yourself.

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
"Work hard, put in the effort, and follow your dreams..." -Me
  • #22
  • Sep 11, 2020 8:36am Sep 11, 2020 8:36am
10:1 winrate is 91%, 50:1 winrate is 98%, then 100:1 winrate is infinite 100500% yes?
Observer effect
  • #23
  • Sep 11, 2020 6:50pm Sep 11, 2020 6:50pm
I aim for 3R trades every time I enter a trade. I don't hit it all the time by any means but that is the potential I need to see before entering a trade. I think what is missed/overlooked in this thread are a few things:

  1. The higher your Risk:Reward Ratio, the lower your win ratio can be but some in this thread have the wrong takeaway and assume you need to win 80% of the time.
  2. 3R is the minimum profit target. If the markets keep going in your direction, you keep hanging on for profit
  3. Losing 1R is the worst case scenario. If price starts moving against you in a clear manner, you can cut your losses to minimize drawdown. Alternatively, if a profitable position shows extreme bearishness, you can close it out early and/or keep a partial runner for continued exposure to the markets.

I skimmed the shared article, and I don't think that the author quite conveys 3R trading in this aspect. I would recommend reading Van Tharp's book 'Trade Your Way To Financial Freedom' or just googling more articles on Risk/Reward Ratios to get a better understanding.

  • #24
  • Sep 12, 2020 5:15am Sep 12, 2020 5:15am
Quoting ryuryu
10:1 winrate is 91%, 50:1 winrate is 98%, then 100:1 winrate is infinite 100500% yes?
This style turns to gambling in some stage.
  • #25
  • Sep 12, 2020 6:12am Sep 12, 2020 6:12am
Just a question to understand the meaning of the discussion.
So, what do you do if you selected a 3:1 RRR whit a sl of 10 pip and when your gain is 22 the price turn to the other way?
The past is already gone, the future hasn't arrived yet
  • #26
  • Edited 10:08am Sep 12, 2020 9:58am | Edited 10:08am
Quoting tzamo
{quote} Hey mate, I see you stumbled upon Jarrod and his articles on risk to reward ratio (RRR). There are some inconsistencies in the articles, especially things like exaggerated examples and heavy bias towards timed exits later on in the 2:1 article. Take his stuff with a grain of salt...especially if you can't replicate his findings yourself. 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...
Hi tzamo

Timed exits and entries is something that I have never actively looked into. There are articles and discussions about that and some of them look interesting enough to try (one day I will). For example strategies around the open and close of the exchanges and other anomalies. I know you have certain tools to probe into metrics of trades and are able to verify the feasibility of a positive or negative outcome by analyzing the data but I'll probably just have to demo trade some strategies based on time to come to a conclusion on that.

On the 'RRR goes hand in hand with % success of trade outcome', I can't help but notice that two are interrelated. Of course the % success is a historical figure. It's based on trades already done. In a new trade, the outcome of the RRR is not decided yet, so I take the % success of expectations as a variable subject to the market's whim. Of course it can be relied on statistically if there is a big enough track record but given the R and R are always subjects of speculation, I tend to want to view that relation after the trades been done and over with. I think the % success vs RRR is just a hypothetical bias and as the % success changes, so does the use of reliability or lack of it when it comes to future trades.

As you say "the more that can happen in between and the less likely it will hit", yes, the distance from 0 to 3 could be long and that's why I figured we could throw in some events in between like BE and trailing stops or even pyramiding. I guess I am not so patient to just sit on a trade and wait for it to mature. I hardly see 100 or 200 plus trades because I'm long out of those trades before they get there. It'd be a totally new approach for me. I do realize that 2:1 RR could also mean 5 pips down and 15 pips up as well but I do know at least one trader in this forum who patiently waits for hundreds of pips to reach his 3:1 RR without deterrence unless that deterrence is the SL.

That brings me to another concern I have about the RRR. What happens if a trader has scoped the market and has decided on a great point of entry that's just money in the bank? He enters it of course and unfortunately hits SL. Then what? Wait for another opportunity? What was wrong with the first opportunity? The trader who deemed the first opportunity to be so great is now in charge of judging another opportunity. He/she either uses the same metrics that were proved wrong by the market to enter another trade. Or he/she has to alter their conditions because the first ones didn't work. What if they sit on the side and wait for a more solid opportunity and the minute they walk away that opportunity comes and goes in a flash proving that their first hunch was correct and the only reason they are out of the market is that they believed in a 3:1 RRR. It'd make their beliefs not quite that solid...doesn't it? And what does that do to their trade psyche? The next time they are prepared to pull the trigger, they'll remember what happened the last time. That is something that beyond scoping the correct entry to the market, a trader has to grapple with. How many entries does a trader allow themselves with the 3:1 formula? What if they are wrong 10 times in a row? At the end of the day, the 3:1 becomes just another discretionary method based on an individual's views and how they read the market.

That is why going the route of "another new trade with different % probabilities associated with them" would make more sense to me. The market is volatile and unpredictable. Why not conform to it's ways and trade dynamically? As they say, take what the market is willing to give you. Structuring your trades into the confines of 3:1 or 2:1 or any ratio is just an arbitrary habit that simplifies having to deal with the dilemma of how long to hold a trade after getting into one. If someone entered a trade and asked me how long they should hang onto it, I could say something like until the trend is over or I can say just multiply your SL by 3 and go with that. The trader A with good trend projection capabilities whose RRR is flexible might even have a better outcome than trader B with the mechanical RRR. I think the proper comparison should be between two such trades instead of comparing their SL hit ratio to their targeted exits.

Are there any EA's with an exact 3:1 RR implemented in their formula? I'm sure it can be entered as such and the difference in the success then can only be attributed to the timing of the entry. That further reinforces my view that the RRR decision is just a convenient method to do away with exit conditions and just focus on the all important entry. Then entry is the king in RRR approach.

The buddy of mine who uses 3:1 rule like it is written in stone tells me money management is the key here. Isn't 3:1 RRR the money management here? What other MM is involved in this 3:1 MM? There could be additional trades thrown in but I think additional trades are viewed as martingale and that is a real no no. It doesn't fit with RRR because it skews the results if nothing else.

Good point on "thinking in terms of risk". To me my entire account is the risk. I can think otherwise but ultimately that is the risk basket. One can compartmentalize risk into risk per trade but as traders, we are not going to place one trade and walk away with the risk of that one trade and we are done trading. Nope, we take risk after risk after risk and like I say, the entire account over the course of a number of trades is all risk unless one becomes so profitable to play only with the market's money but when earned, that money is not really the market's money because it was earned by allocation of time and effort and most likely other financial costs as well.
  • #27
  • Sep 12, 2020 1:01pm Sep 12, 2020 1:01pm
This video really encourages the 'Sit n Wait' approach to just let the 3:1 target to be reached.
Inserted Video
  • #28
  • Sep 12, 2020 1:45pm Sep 12, 2020 1:45pm
This is an old thread on the subject. https://www.forexfactory.com/thread/...ystem-1?page=5

I like the idea of testing RRR based on a random entry just to see what kind of results are generated. That thread starts the attempt but very soon gets derailed by what 'random' is.

Did that experiment clear anything? No.
  • #29
  • Sep 12, 2020 1:48pm Sep 12, 2020 1:48pm
Quoting Arty76
Just a question to understand the meaning of the discussion. So, what do you do if you selected a 3:1 RRR whit a sl of 10 pip and when your gain is 22 the price turn to the other way?
If you've really selected a 3:1 RR then you should wait til your tp or sl get touched, even if it means letting price go up 29 pips then turning back down and touching your sl
  • #30
  • Sep 12, 2020 4:20pm Sep 12, 2020 4:20pm
Quoting metta87
{quote} If you've really selected a 3:1 RR then you should wait til your tp or sl get touched, even if it means letting price go up 29 pips then turning back down and touching your sl
Ok understood.
A little more than gambling. Nothing more.
The past is already gone, the future hasn't arrived yet
  • #31
  • Sep 12, 2020 4:22pm Sep 12, 2020 4:22pm
Quoting Arty76
{quote} Ok understood. A little more than gambling. Nothing more.
Yet a few traders are doing it apparently successfully according to some of the comments in this thread.
  • #32
  • Sep 12, 2020 5:40pm Sep 12, 2020 5:40pm
I assume if you enter randomly, you will be able to predict your win rate based off your risk reward ratio.
For example, 1R will give you 50% win rate. 2R will result in 33.3% win rate. 3R will = 25% win rate. ext..

Which goes back to Hayseed's post in relation to entries being the ultimate quest.
  • #33
  • Sep 12, 2020 6:32pm Sep 12, 2020 6:32pm
Quoting Horne
I assume if you enter randomly, you will be able to predict your win rate based off your risk reward ratio. For example, 1R will give you 50% win rate. 2R will result in 33.3% win rate. 3R will = 25% win rate. ext.. Which goes back to Hayseed's post in relation to entries being the ultimate quest.
Yes without slippage. But the slippage exists, so the percentage is different.
The past is already gone, the future hasn't arrived yet
  • #34
  • Edited 9:15pm Sep 12, 2020 7:36pm | Edited 9:15pm
Quoting OutThere
Hi tzamo Timed exits and entries is something that I have never actively looked into. There are articles and discussions about that and some of them look interesting enough to try (one day I will). For example strategies around the open and close of the exchanges and other anomalies. I know you have certain tools to probe into metrics of trades and are able to verify the feasibility of a positive or negative outcome by analyzing the data but I'll probably just have to demo trade some strategies based on time to come to a conclusion on that....
If a trader(me) trades with fixed RR, he does not cheat by getting out with breakeven stop or trailing stop management.

The key to such a strategy is to execute solid entry that survives the fixed stop loss. The entry is important, the exit is predetermined.

For intraday trading 1:2RR, trader will be looking at 20pips profit and 10pips stop. To survive 10pips stop trader trades currencies with 50-70 adr and small spread.

If you try to trade say gbpaud, it gets a lot harder with 10pips stop because of both the longer tail and wider spread. Not impossible but much more difficult that demands close to perfect execution. For pairs with adr above 70pips traders use 20pips stop. If the trader requires wider stop then forget about RR strategy, it not suitable for him. Try scalping, cost averaging, basket trading, nedging or a combo.

There's only one way to trade fixed RR with fixed stop that's repeated in daily or weekly cycles, if anyone use his brain to figure this out. If I see anyone's trades I know with certainty if this trader can trade based on fixed RR or not. Look at the survivability of his stop.

About win rate for say 1:2RR, you'll be surprise it's quite high. Else traders of fix RR won't trade this strategy.

Ofc it's not too difficult to figure out the merits and benefit of this strategy. The downside is waiting time which can only be mitigated by the aid of proper alert tools.

The comparison between 1:2 and 1:3 RR is not in the reward side. It's how many signals within a day or week. 20pips profit makes more sense than 30pips profit within a day for say EurUsd. For a week cycle, 20pips stop 60pips profit. This depends on currency and their characteristics. The larger the RR the lesser the trader has control vv. The natural boundary of the pair creates the limitation.

To fix RR traders, it's not about how many pips gained or high win rate but how many RR's gained. That's the difference and a huge one that has direct impact both on risk and reward, a form of trade risk management. Probably the only risk management strategy for directional speculation of Forex besides hedging using other assets class.
Know what you trade
  • #35
  • Sep 12, 2020 10:55pm Sep 12, 2020 10:55pm
Quoting BWilliam
{quote} If a trader(me) trades with fixed RR, he does not cheat by getting out with breakeven stop or trailing stop management. The key to such a strategy is to execute solid entry that survives the fixed stop loss. The entry is important, the exit is predetermined. For intraday trading 1:2RR, trader will be looking at 20pips profit and 10pips stop. To survive 10pips stop trader trades currencies with 50-70 adr and small spread. If you try to trade say gbpaud, it gets a lot harder with 10pips stop because of both the longer tail and wider spread....
Thanks for the explanation. Seems like the RR traders are in a club of their own.
I've been told that MM is a big part of RR trading. It is apparently what makes the difference.
Can you explain beside setting the SL and TP according to the proportions of the RR, what else is used in MM since trailing and adjustment of targets isn't advised?
I see that position size is important down to surgical precision. I mean why would an RR trader choose a size like 2.81 or 1.59 lots? I have seen that sort of position sizing in old trades of a trader here. Why not just use round numbers?
  • #36
  • Sep 13, 2020 12:04am Sep 13, 2020 12:04am
Quoting OutThere
{quote} Thanks for the explanation. Seems like the RR traders are in a club of their own. I've been told that MM is a big part of RR trading. It is apparently what makes the difference. Can you explain beside setting the SL and TP according to the proportions of the RR, what else is used in MM since trailing and adjustment of targets isn't advised? I see that position size is important down to surgical precision. I mean why would an RR trader choose a size like 2.81 or 1.59 lots? I have seen that sort of position sizing in old trades of a trader...
Different pairs have different pip value. For continuity you should normalise pip value by adjusting lot size. Eg. A pip in eurgbp is is not equal to a pip in gbpnzd.
  • #37
  • Sep 13, 2020 12:16am Sep 13, 2020 12:16am
Quoting BubaYaga
I think the 3R type trades are easier in trending markets. Entering after a pullback you can keep stops relatively small. {image}
Here was the result from that trade I showed in my last post. As price went higher, on each pullback as long as it was a higher low, I would adjust target and stop loss. As you can see SL was above entry when trade hit TP. It started as 3R, but obviously wasn't a 3R trade when it closed because R had been eliminated.
Attached Image (click to enlarge)
Click to Enlarge Name: 3R trade result.jpg Size: 34 KB
  • #38
  • Sep 13, 2020 12:38am Sep 13, 2020 12:38am
Quoting Horne
{quote} Different pairs have different pip value. For continuity you should normalise pip value by adjusting lot size. Eg. A pip in eurgbp is is not equal to a pip in gbpnzd.
Thanks. Intowesting. Continuity of what tho? What are we continuing? Sorry if it's a dumb question. I have never approached trading for long range targets. I get it that this is a ratio and the extent can be whatever the trader decides. In my mind I'm thinking of the -100-+300 range and it's out of my range foe the planned TP target trading that I am used to but it's probably not even a high range as some aim for a TP of 800 pips on a regular basis....patience isn't one of my stronger virtues.
  • #39
  • Sep 13, 2020 1:12am Sep 13, 2020 1:12am
I only look at the $ value in my trading. I realize that you need to describe levels by pips in order to set the R levels...but maybe % can be used too. I was never really a pip trader...
I'm sure there are indys n scripts n what not for everything.
  • #40
  • Sep 13, 2020 1:20am Sep 13, 2020 1:20am
Quoting OutThere
Thanks. Intowesting. Continuity of what tho? What are we continuing? Sorry if it's a dumb question. I have never approached trading for long range targets. I get it that this is a ratio and the extent can be whatever the trader decides. In my mind I'm thinking of the -100-+300 range and it's out of my range foe the planned TP target trading that I am used to but it's probably not even a high range as some aim for a TP of 800 pips on a regular basis....patience isn't one of my stronger virtues.
The MM ties in closely with the RR strategy.

Say for example the trader starts with a $100 account. He risk 5% a trade which is translated to the lotsize based on the stop he uses and the pair he trades which have different pip value. The common factor is the stop and $value risked a trade. All these numbers are fixed and predetermined. Another model is step like where adjustments are made when the account balance hits a certain high point, eg. 100% return, or low point, eg. 50% accumulated loss. The result is every trade has different calculated lot size where the trader don't make any discretionary decision.

Continuity means that the every trade has to maintain the same base structure input with the lotsize as the calculated variable output which gives these type of decimal type numbers. All to remain inside this MM strategy which guides the whole grand scheme of things. There are changing broker's requirements and limitations as the account grows so the specification changes accordingly. This doesn't go on indefinitely, it reaches a certain optimum when it stops to reflect fix value risk per trade that's comfortable and suitable to the goal of the trader.

As to the range of the RR, for intraday trader, 20pips stop with a 60pips tp for GBP pairs. Or 50pips stop with a 150pips tp for the week as example of 1:3RR trades. It depends on which you prefer how active in trading the market, your risk tolerance and your trading objective. Anything wider than this you may have to be more patient. It all comes down to what the market offers that's down to the trading range of the pairs, the timeframe and current volatility.

Growing the account this way gives a calculated risk approach that's maintained at every instance no matter what the last trade outcome may be, the trader has covered all the angles. He just have to focus on making solid entry execution.
Know what you trade
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