Reward for your Risk: FX vs other Business

Im sat here thinking In to the early hours of the morning and a question came to me, one that I have no definate opinion on, so I thought I would just throw it out here and see if anyone bites.

Why When trading do we expect to win atleast what we could lose on a trade? As far as Im aware when selling most physical products retailers dont expect to make 100%+ profit, do they? It just seems a little strange that we should expect to when trading FX.

Is there anyone In the forum that Risk's more on a trade than their expected Reward? Im mainly interested for people who have been trading for atleast 6 months with possitive results In this way to respond, there may be nobody here that fits this spec though.

Obviously anybody else with an opinion Is welcome to respond....

Leon

[i]Is there anyone In the forum that Risk's more on a trade than their expected Reward?/I]

Interesting question. To answer yes may infer that one would be either a compulsive trader, or possibly very good at recognizing a poor long term decision before the damage is done? But not early enough to avoid the trade altogether?

Or, maybe said trader is confident in his pick, but also realizes and accepts that volatility may precede his expected move, and is consistent enough in his success to justify said SL strategy?

Hi Leon,

Given all else equal,

Risk more for less reward would provide higher probability of winning.
Risk less for more reward would gives lower probability of winning.

Higher RR lower probability, vise versa. Both can make money it depends how you combine strategy and positioning. But how do you strategize?

Hi Leon,

I think you are probably one of the most active posters here on FF for the moment. It seems to me that you are very eager to accomplish as a successful trader. I seldom post, but I think I may just share some observations which may be helpful.

Well, I have been long enough here to notice that a lot of traders (including those who shared good knowledge and those who claimed to be highly profitable traders), have already become inactive or completely left the forum. This actually tells you the extent of success associated with fx trading.

A lot of people like to see fx trading as synonymous to a business. I would say that trading can be seen as a business, but not the kind of fx trading most people are doing here. In business, say product retailers, actually own stocks that have value, which largely depends on demand and liquidity. On the other hand, trading can be seen as a business too. Consider a metal trader who actually owns metal and sell it when demand is good and price is high. Now that is real trading. What most people do here is speculating. They are buying a useless contract without any inherent value with the hope that the value of the contract will rise. Don't you think spot fx trading is remarkably similar to CFDs? It is akin to paying for a hope which may never materialise. From the look of it, it seems to resemble lottery as well. Furthermore, it doesn't make sense from the business point of view. Note I said "They are buying a useless contract". It's like paying the employer to get to the interview when applying for a job.

To summarise (I put options here as well),

 

1. Retailer: value mainly depends on demand and liquidity (provided stocks do not expire)
2. Commodity trader (FX included): value mainly depends on demand
3. Online spot FX trading: no inherent value, but will gain value when price goes in the right direction, loss is guaranteed but gain is not.
4. Options trading: Intrinsic and extrinsic value. It gets interesting here because you can choose upon what the value will depend on, like time, volatility, underlying price, etc. There's a lot of debate here and they are not part of the scope of this discussion.

Another point I want to make is the reward:risk spectrum, which Belief has already mentioned. A respected trader here, has once said something like this "You need to be net long when the price is rising and net short when the price is falling". My interpretation of his statement is this "your total pips gained and lost must be positive to make a profit". Well, I respectfully disagree.

Best of luck in your trading
J.

Thanks alot for this post J, It made me want to check out some of your other posts and there are some interesting thoughts there.

I beleive there is an edge to be had by risking more to gain less(obviously this involves a high hitrate), and after alot of thinking the reason for the edge(I beleive) Is the smaller random fluctutions In price made by people establishing possitions and confusion over the markets nextmove.

If I, as a trader, can trade the Ranges/noise In the direction that I beleive the pair is headed(eg. Away from a large rejection of price) with a Stop-loss beyond where I would consider Random fluctuations would reach, considering that markets range most of the time, then I could come out ahead.

I combined this thought with an averaging down strategy In my journal and came out with some decent results, some trades I would lose pips but gain $. Im still considering going live with it in the coming weeks with a small account to see how it fairs, Since I havent found a way to mechanicaly backtest due to the discretionary element In deciding likely direction... testing on a small live account Is the best way to realy see what happens.

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Regarding the content of your message-- The people who trade FX do beleive that their possition Is worth something because they think they have got In at a good price. So far I have not found a technical way to determine a good price, I have only been able to decide on a direction and then average as price moves against me to make up for the fact. (PS. Obviously all is done with strict risk controll)

Leon

Leon, I'm sat on the other side of the fence I've backtested hundreds of systems, both discretionary and non-discretionary ones and spent a lot of time playing around with the R:R and came to a single overall conclusion:

If the system has an edge, it can work with a 1:1 ratio - ie TP=SL. Increasing or decreasing the reward then sometimes increases profits, sometimes not depending on the mechanics of what the system is. Either way, the crucial success factor is that this kind of binary trading works. And if it does, then play around with the MM to see what's most optimal.

Using this filter for what works and what doesn't I've found incredibly valuable. You either have a win rate > 50% or you don't - it's either worth looking at or it isn't. It works even for long-term trend systems; widen out the TP & SL to far extremes, and if your signals are good, you should be getting significantly >50%. Obviously, with trending systems for eg, you wouldn't then actually trade it 1:1 because you should be able to get more profits using some mechanism of catching the trend.

The biggest danger of inverse risk:reward is that it clouds the issue of whether you've a profitable edge or not. You're suggesting that the R:R can be an edge in itself; I'd disagree and say it's a means to exploit the edge, which could be any set of values.