Risk/Reward Ratio and the power behind account growth

I have been an active trader for the best part of 4 years now and only recently have a been having some good success. Until recently (before December 2008) I had made my way steadily towards the abyss of failure (i was failing but hadnt reached failure) through a complete lack of discipline in all areas (plan, method, MM and risk etc)

I had a change, a big mental shift, and it is what I will get into during my little ramble. I hope to get some feedback from others in the same situation or even those who are struggling and find this thread useful.

2009 was like a final straw. I had been circling FF threads like a hawk trying to find the answers to a question I hadnt thought about. I was looking for something that would give me the best bang for my buck (free), a system that would be flawless, unparalled in profit vs loss and something that would allow me to relax. I searched end to end but alas couldnt find anything. I did however come across a thread that was interesting that really opened my world up. While the thread was interesting it was more or less 2 individuals whose words shocked me into reality.

From there I did some research, read more on one of the particular individuals who out of the 2 has changed my mental approach greater and whose work I have implemented into my trading since becoming aware of it. I will admit that at this time I do not follow it 100% as mentally/emotionally I am not completely ready for the full experiece, however thus far it has significantly improved my trading in all aspects.

The individual is Joel Rensink and his workings on Infinite Yield have shaped my past 6 months of trading, given me the biggest 'light bulb' moments and have created much deeper trades than I would previously challenged. However im not here to right a biography on the above, but more or less add to something that happened (a number of times) that I dont see much in the areas that I thought would (sounds confusing, I elaborate)

I have recently been trading 2 systems, both have proven to be very useful however while they do offer a good robust history, they are typically long term trades requiring a greater TF outlook in order to secure maturity, which suits my current lifestyle to a T. I was however last week looking at a very low timeframe thread (a couple actually) and while I liked what I saw (im not suited to long hours in front of a screen) in terms of method, there was a limitation placed on profit, as is the case with most scalping. This lead me to wonder.

Most (if not all) of my trades are taking with the outlook to try to maximise the Reward factor, and this stems from the workings of Infinite Yield. It is about holding trades for as long as they stay in the field and trying to get the maximum out of them. The downside is that you will at times take some losses when there was ample gains. Now I know what most of you are thinking but bear with me. While the gains can become losses (unless you adopt a half off at 1:1, a move to BE after X pips(both of which I do use)) when the market rallies for a long period of time your original position can stay intact for a long time. Sorry if this seems like dribble, i will try to get to the point soon.

So while reading some of these 1 minute, 5 minute and 15 min threads I was surprised to see very few, if any traders take trades for a great period of time. Most risked x pips and took profit a x pips (some a x-2) which to me seemed very limiting.Now this is where I am looking for discussion because I dont trade very often less than 1 hour (and even that seems taboo sometimes) so my experience in this department is limited. So my wondering and thought process was, If you took a trade on a TF of say 1M, where the risk was very small, in most cases 10 pips including spread, and where able to hold, your reward could be potentially huge.

SOOO instead of wondering too much longer I took my PA outlook and began plotting some lines on a TF that suited me, came up with a small plan, dropped TF to 15 mins and waited. I didnt have to wait too long. There were new Lower Lows and Lower Highs forming and I simply waited for a PA candle to form after a pullback to a previous LH (which I got as a shooting star or 10 pips risk total) and set a trade for the break or that candles low. I got it almost immediatly and my 2% was on the table. Well something must have favoured me, I was with the greater trend down according to daily charts but I still was surprised by the swiftness of the move. It broke down almost 30 pips (3x R/R) in the 15 mins which prompted me to act on my SL. I would normally take 1/2 on higher TFs, however this particular time I was happy to just move to BE.

The trade continued, and after moving to BE I left for about an hour knowing that the worst case outcome (providing something funky didnt happen) was a BE result. What I got was just over 100 pips. I exitted the trade (because I was overwhelmed more than anything) at close to 10x Risk Reward profit or over 20% account growth. The trade continued south a further few points and that is what I want to get at primarily.

At that moment I had a small mental shift. Account growth/decay is the end product of successful and unsuccessful trades. I have looked at Risk/Reward as an important fundamental to having a growing account. So for me the question was more is it possible to do on a regular basis? Can you take your small risk trades on small TFs and mature them past a point of limitation? I read 1 of the posts (from a 1 minute thread and ill post the author if I find it again) that said 1 minute charts are like trading the live market, the action is happening there and then. So in this event if you got in with a small risk and could hold, your small risk could be the trade that changes your account forever.

Im not a get rich quick guy, in fact the opposite since having the mental shift. My thought process came about after the experience. If it was possible, and this is once again where I am unsure due to my lack of small TFs, to take 2 or 3 trades a day, average risk 10 pips, and hold them then are there traders doing it currently it. From a R/R POV there would be a compelling argument that the smaller the TF the better the opportunity for a huge reward against a small risk.

Feel free to post your thoughts. If I can add anything to the madness I will. Please understand this is not my usual way of trading and seldom do I take more than 3-4 trades a week. I know there are a number of people who have stated they trade small TFs, so if the method has a definable edge, is it possible to take a much longer outlook to profit taking.

Thanks for reading my dribble lol

Happy trading

Razor

Shame this thread didn't get any interest. I trade daily supply/demand zones. Within the brackets of the daily zone I identify a supply/demand setup on the hourly. I then scale into the 15min and trade off highs or lows on pull-backs, and place my stop behind the previous high low. The reason I don't trade SD zones on the 15 min (as with the H1 and D1) is that the signals are less reliable.

By scaling from the daily SD level to the 15 min chart within the bounds of the H1 I am looking at the bigger picture but placing my risk on the lower time frame. Sometimes these SD zones on the hourly within the daily reject price very fast and it may happen whilst I am not at the screen. So initially I set the trade up on the hourly with my entry on one side of the zone and my stop the otherside of the zone and only adjust to the 15 during day trading hours. Targets are off the daily at the next SD zone.

My first experience with unlimited reward was First Strike as well. I trade differently now, but I'd recommend trading First Strike to anyone--even if it is only trading tiny amounts. A very good method to have working in the background. Why? Besides doubling a small account dedicated to FS over a period of 6 months, there was the experience of seeing 1500 pip winners in a single week. Certainly not every week, but it helps us learn what is possible by not limiting our reward. It's much easier holding a larger trade after the experience of already having done it with smaller ones.
When I traded First Strike regularly, I managed my trades differently than Joel. Early in the week I managed the trade exactly like he did, but if I had a trade well into profit (several hundred pips) by Thursday, I would definitely protect it by tightening my stop more than Joel did. Or maybe even close it Thursday evening. At that time, we didn't hold anything over the weekend--ever. So in a way we were limited by the week's end anyway. Our results were ultimately very close. Joel is all about making things your own by testing.

To get back on point, it's been my experience that having a one-size-fits-all R:R approach is a poor way to go. Especially if it is chosen arbitrarily. One of the best traders I know uses a risk to reward that 90% of the members here would say is guaranteed disaster. But his results are published and indisputable.
To use a low risk to reward, you have to have confidence in your method. A string of small losers won't phase a true "long-tail" trader who has confidence that his method will turn up a few homeruns that will quickly cancel out the losses. One of the biggest problems new DIBS traders have is being able to handle the strings of small failed entries while keeping their confidence up.
On the other hand, a grid trader has to be able to stomach the occassional deep drawdown by knowing that his win to loss ratio is incredibly high and, if his method is sound, ultimately high enough build the account.

A point to remember Razor-Trader, is that if you're trying to get into a long tail trade with a very tight stop you are essentially picking the lowest price not only on the short term chart, but obviously, all charts. The price is the same, but the landscape is different. By lowest price, I mean the lowest price of your chart from the moment you enter the trade until whenever. Not that this can't be done. It seems porkpie has invented a way that works for him.
In other words, if you're trying to invent a plan using a low risk entry, make sure you've found a definitive way (like Porkpie has) to keep from getting shaken out continuously. When that short term entry looks good be sure to zoom back out and see how it looks on the next few higher TF. So you've found a good entry on a 5min chart. Zoom out. Does it look likely that normal price swings will stop you out? What is you time horizon? If it's several days, how does your entry look on the 4hr chart? Your tight stop entry might look a little different on that landscape.

I notice a number of people had read my ramble but no one had replied so I stopped looking at it. It is merely information that over this year culminated into the above after watching/reading threads with very tight SL, and trying to perhaps work into that landscape a larger reward mentality.

Thanks for your reply (you to Porkpie). My thinking is going to turn into a challenge for myself. After doing some further reading I am trying to come up with a plan that on small timeframes may allow for long term growth. It is definatly possible and my biggest challenge is going to be to overcome screen time which is something I am not comfortable with, but in life to progress and evolve sometimes you need to step out of the comfort zone. This is will essentially be a challenge to myself so it will not replace the normal trading that takes place (and has priorty) but I feel an itch so I may aswell scratch it.

The challenge will use much of the trading habits I use for dailys and I will be working on ways to incorporate those ideas into smaller TFs. Because the aim is for long growth the benefit will be no having to risk the house per trade. I will be in most cases trading 1% or less as I do with my normal setups, only going bigger if I feel there is adequate reason for it. Im sure it will be a hoot

Thanks for taking the time to reply.

Razor

I second what billflet said.
I spent a few weeks thinking about longtails and designing testing algorithms. Those pieces of code, as you may know, require rather specific details when you are about to code them. But my problem was that I didn´t have anything in my hands and I felt the need to have something well defined, very specific, rock solid. It was driving me crazy. So I reversed the thinking process. What qualities does the longtail trade have? How would you describe that kind of trade? Answer that and you will move forward one step.

We´re not here to trade longtails only. But we are here to make sure, that if the opportunity comes around, we HAVE to take it no matter what.

Razor already mentioned the Risk:Reward as important factor of account growth/decay and I confirm that. Going to the practical part - how to get those trades without losing patience/nerves/equity - is not that easy at all. I tested few timeframes (created from reliable hq tick-data) from M5 to D1 and each of them showed different results. I do complex trading simulations in Excel (including account equity monitoring) in order to see what effects does having few BIG trades running your way have on the equity curve. In the longtail case - as it was already mentioned - we are picking tops and bottoms. We have to. When trying to do this, we have to realize, that the lower the timeframe, the higher the trading frequency (decreased winrate deepening the relative DD), but also the lower the size of SL (allowing for amazing R:R situations).
What are the implications of this? There are several. I tell you one.
You can´t bet your house on each trade, because your accuracy won´t be that high (winrate is loooooooooooooow).
I never understood what PC and Joel were talking about when they mentioned "Do YOUR OWN RESEARCH" on several occasions. What´s the difference between somebody posting his testing results and me doing my own? At first sight, there is no difference. I bet that your perspective quickly changes when you are about to go live with rather not-so-insignificant account.

Bluefish

I just noticed this thread. Great points, everybody.

I see it this way: that (at least in the short term, and everything else being equal) RR and win rate are approximately inversely proportional to each other, creating a kind of equilibrium. Hence I try to use other factors (support/resistance 'quality' and confluences; time of day; average daily move; overbought/oversold; direction of longer TF trend; negative correlation) to break this equilibrium, thus delivering overall positive expectancy.

See the attached chart, a trade I made last night in my demo account. Entry was at the white line/arrow. Stoploss was 4 pips (red line) + 1.5 pip spread. That's crazy, right, noise will shake me out? No, that's the whole point. If the very strong flipover S/R fails to hold, then I take the trivial 5.5 pip loss, and then look for another short entry point in the emerging downward move. My profit targets are (1) the very strong daily S/R confluence point; (2) the daily central pivot point, and (3) I decided to close the rest of the trade on the close of the large red candle (lucky guess in that the move ended there, but large candles are often followed by a decent retrace).

The overall result was about a 6:1 trade. I risked 0.5% (of a demo account, LOL, but I take demo seriously) and made ~3% in a few hours. (Compound 3% per day, and the annual return is…… LOL again). In hindsight, the trade should have been more than 6:1. If I'd had the confidence that I'd picked the major move of the day, I could have exited less of the position at TP1 and TP2, and let more ride to the final exit. Also, I could have used the subsequent flipovers at the TP1 and TP2 levels to add to the position; if I'd traded it this way I could have ended up with something like 30:1. But discretionary trading is very much a slow learning process.

Of course I don't know in advance which S/R levels will hold. But I look for strength, and confluences with other factors (additional nearby S/R, pivots, round numbers, and sometimes key fibo levels). Flipover S/R is stronger than homogeneous S/R. If I can find 3-4 reasons why I think the level will hold, then I'll place my SL just outside the farthest key S/R at that level. I filter out trades if much of the average daily move has already been exceeded; if there are key news announcements imminent (that are likely to blitz technicals); if making the entry would mean that price is quickly sailing into an even stronger S/R zone. The goal is to use an emerging move to determine direction, and try to enter early enough to catch a decent chunk of the average daily move. I also use the D1/H4 trends as a guide, and ensure (using this indicator) that I'm trading negatively correlated currencies against each other (hence I stay right away from UJ, EF, etc). I am still very much learning and experimenting as to how to optimally weight all of these factors.

I've digressed from the RR topic, but my goal is a low risk entry, allowing me to more easily shrug off losses. Jacko's anti-hedging strategy gave me the idea that if a trade fails through an unfortunately timed entry, there's almost always another opportunity to re-enter a move, and recover the loss. In the way that I'm currently trading, low risk entries are key to achieving high RR trades; one major reason I've always believed that entries are more important than exits. If I'm making enough 5:1 trades, then I can afford to mis-time a few entries, and still attain overall positive expectancy. Looking back over past charts, I've seen the occasional big moves that would have given me upward of 20:1 – that's 10% return in a day, while still maintaining tight rein on risk, wow, dreamlike.

For the record, the thick bands on the chart are key D1 candle highs/lows that are pre-plotted by this indicator. The dashed lines are pivots (PP=green; S1,S2,S3=blue; R1,R2,R3=red) and the gray dotted lines round numbers (00 and 50).

About Joel Rensink's long tails. If I understand correctly, Joel and his friend Peter Crowns use low risk DIBS-like entries as an access point to the carry trade. Joel talks about all of this in Unique Edge #1 here.

There's a very interesting thread here. My (albeit limited) experience is that if S/R is going to hold 'properly' on an intraday (e.g. M30) chart, it occasionally does so with the 'deadly accuracy' that's described in the thread.

I'd be justified in setting a 3 pip SL, instead of a 6 pip SL, for example, if there's less than double the probability of being shaken out by noise. Now if the S/R level does happen to hold precisely enough, I'm going to get double the RR (e.g. a 10:1 trade instead of 5:1, on a 30 pip TP), by taking that extra 3 pips worth of 'risk'. Or alternatively, I now only need a 9.1% win rate (1 win per 11 trades) as opposed to a 16.7% win rate (1 win every 6 trades) just to attain long-term breakeven.

To what extent does being more selective in one's entries (picking 'quality' S/R, for example) improve overall expectancy? I think it's significant, but I need to get a few thousand more trades behind me before I can say so with any degree of certainty.

Re account growth, obviously frequency (turnover) of trades has a huge bearing. Suppose I average 1% growth every 10 trades. If I have a methodology that's capable of making those 10 trades in a week, rather than one that trades 10 times per month, then obviously the growth - when one takes compounding into consideration - is going to be much more than 4 times (1 month = ~4 weeks) greater. Of course it means that losses will compound more quickly also, but we're not trading unless we have some kind of positive expectancy, right?

Of course. Frequency is the most significant IMO when it comes to account growth. The message I was trying to spread was that many people get discouraged even with good setups, because they can´t handle the frequent losses. However, if they did some proper testing, they´d see that those losses are part of the usual way the chosen method operates.

Good points hanover!

Bluefish

Losses are part of the way any trading model works, regardless of whether one believes it or not.

All great points and it adds fuel to the desire to give it a try. Better to have tried and failed (mulitple times if necessary lmao) then to never tried at all.

I am glad to see some imput into the way I see some things. R/R, win ratios and growth are all part of a bigger picture, and I see the potential for aggressive reward building with the right mindset. It isnt the be all and end all, my thoughts are always based on what I have seen over time and the replication of possible event.

Digging deeper into my mind of madness I have been running some tests on what I want to get at, and the results which at the moment have only been done with about 6 months of data, have been great. Some of the results pretty much hit home and hanover was kind enough to share some tight SL and rewards that would be highly feasible (10x TPs). My testing has a few trades with risks of around 5-10 pips (plus an ave of 2 pip spread) that have been held for well beyond 300-400 pips (again only into around 6 months of testing). With that in mind you could easily risk a very small portion, as low as .2% of account and still achieve phenomenal results from a growth standpoint. This is the long tail, small risk theory that I am after that eleviates to much emotional involvement because then risk per trade is very small, which allows more freedom (theoretically) to hold trades well past the norm.

With all the above said though there is still one small problem (even from a sub conscious view) with backtesting and that is that even at a slight level you know where the market has to go to because in most instances you have lived through that period (trading experience) so for me with the pair I am testing, while trying to testing flawlessly there will always be the hindsight knowledge that I know where we are at, and where we have been. This allows a small confort when holding trades, especially if the market is at, about to get to, or just moved from an area of absolute bottom and therefore you are now in at a position that you now, will not be seen again (for example the .6200 area of the AUD/USD). SO as all things go I take my backtesting seriously, the results are meaningful but I still allow the thought that it may take a long time in the current market to perhaps replicate the same results.

I will keep you up to date, either here or a new thread once I have finished testing and am going to start trading it live (either live or demo).

Thanks all for you input

Razor

That was my main issue when checking charts only a few weeks old. But as I went through more history, the "pattern recognizing" part of my brain started to mess up my judgement. Hence the need for mechanical testing (programming) on my side.

Bluefish

Pardon my ignorance, but what is a "long-tail" trader? Is that someone that enters a trade based on a candle with a long tail wick? Or is it something else?


Topgun

A long tail trader is someone who trades a methodology that has a low win rate(number of wins divided by total number of trades) but the winners are really big to compensate for the frequent small losses...

Yes, this will make for some great RR trades. In post #6 I provided a link to Joel's long tails thread, where he was discussing trades with RR of 200:1 and higher. I think he also mentioned taking partial profits along the way, which would lower the overall RR. An alternative could be to run a trailing SL to lock in profit on the whole position, as it moves forward, but of course we would somehow need to keep the SL wide enough to prevent premature exit, yet close enough to ensure that not too many pips are forfeited when the trend finally reverses.

Every approach has its pros and cons. I read on another thread (can't remember exactly where, sorry) that maintaining a long term position meant potential lost opportunities elsewhere (although obviously that depends on position size, and hence margin used/available). Another possible consideration is that a shorter term trader might be able to capture more 'zigs' and 'zags' along the way, gathering more pips overall, and also compounding his gains more frequently. In other words, ten 5:1 trades across a given timespan would probably result in a greater profit than one 50:1 trade.

At the end of the day there are (at least) four variables - win rate, RR, trade frequency, and MM (position size and method) - and it's a case of somehow juggling these in a way to try to optimize the profit vs drawdown equation.

In his infiniteyield webpage Joel discusses the advantages of exploiting the carry trade. I'm the world's worst economist, but when there was a 7-8% differential between the NZ and Japan interest rates, it was something of a no-brainer; the greater differential supposedly being more likely to override other economic metrics and factors. The global crisis has narrowed the gap, and also made things more complex and fickle (I expect national economies will convulse, relative to one another, as more undisclosed debt comes out of the woodwork...... my gut tells me that we're not out of the woods yet). Hence long tail carry trades might not be quite as straightforward as they were in yesteryear. We live in interesting times.

Long tails with negative interest can also be a problem as the longer you hold the trade the more negative rollover you recieve and if in the end your gains dont outweigh that rollover then what is the point which brings me to the carry trade situation and why I look at pairs that carry strong interest differences (AUD pairs are a good example so far).

I have also been following alot of Joels work, Infinite Yield as you can tell is a huge part of my thinking. You are correct though, I have read a number of books, the most recent being Bird watching in Lion country which has a compelling model with the 4x1 strat. The only concern with this is there is no hard SL and trades can be left out of the money for sometime provided you are still with the trend. It also sounds alot like the averaging loosers in the hope the market will come green before you go bust, but obviously it is up to the traders judgement with all models.

The hardest thing to swallow is the small losses at first, they can eat into your capital. However as you mention a trade that runs 200:1 can quickly catapult your capital (not quickly as in time, unless you get lucky, catch a 10 pip risk trade on the G/J and it runs some 1000 pips in a week which is possible with that pair). I also use historical markers to ease my mind. Looking at where the market has been over time, the conditions that where present (economical) and where we are at now to give me an indication of possible gains from point X. GBP is a great example of potential into the future. it is still a great number of pips from where it was and in time it may visit and smash through those highs, but time will tell and whether 1, including myself has a tail (and the emotional stability) long enough to attain such a great feat.

Take care all

Razor

The term "tails" refers to the tails of the probability distribution curve. A curve that has long tails means that every once in a great while, a very improbable event will happen (otherwise known as a "black swan" event). So a long tails trader is banking on these infrequent events by taking frequent (highly probable) small losses while waiting for infrequent (improbable) very large gains.

Thank you to Eklavya and capitalist88 for explaining what a long tail trader is.

It is a really intriguing concept of trading with the idea of scoring huge wins ... while using a very small risk per trade. I have actually considered trying this type of idea on demo. However, I didn't know there was a specific name for it. lol.


Topgun