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Attachments: Risk Reward: 1:1, 1:2 or 1:3
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Risk Reward: 1:1, 1:2 or 1:3

  • #21
  • Nov 1, 2010 10:05pm Nov 1, 2010 10:05pm
Quoting tradpat
This is just my $0.02.

Assuming winning one trade based on 1:3 is $3 while losing is $1.
For 10 trades, 3 winnings vs 7 losing

On the other hand winning one trade on 1:1 is $1 while losing is also $1.
For 10 trades, 7 winnings vs 3 losing

If you are comparing the two, the number of winning and losing trades should be the same for an accurate comparison.
  • #22
  • Nov 2, 2010 7:28pm Nov 2, 2010 7:28pm
well, just a thought Id look up a couple of terms called infinite yield..and long-tail probability.

the idea of Risk:reward is really to understand your trading performance .. not as a lock in of you have to risk x for x every trade.

for example if you make 100 trades you can take the results of those 100 trades .. say you have a maximum risk of 1% everytime.. then the profitability distribution looks like the picture below the bulk of trades rotating around -1% to +1% with a smaller amount of probability of trades skewing off into large profits.. understanding risk:reward in this way will help you understand efficiency in trading as well

the better the efficiency and better you can skew the profit distribution the more of an edge will exhist..
  • #23
  • Nov 3, 2010 4:45am Nov 3, 2010 4:45am
Quoting Special One
TP and SL should be defined before we take the trade.
How we define TP and SL should be base on Support and Resistance, not by exact RRR.
After define TP and SL, count the RRR. If the RRR is not satisfy you then don't take the trade.
The situation in which we take the trade does not remain static. Not being able or willing to adjust as the trade plays out is a liability.

As for which R:R is best, higher winrates are preferable. I see a lot of talk of coinflips and high reward vs risk, but a high winrate with a small edge will perform better over time than a low winrate with a large edge. Why? Because risk is not equal, and the high winrate allows for a better risk-adjusted return. This is far more significant than most realise.
  • #24
  • Nov 3, 2010 6:51am Nov 3, 2010 6:51am
Quoting Mr J
The situation in which we take the trade does not remain static. Not being able or willing to adjust as the trade plays out is a liability.

As for which R:R is best, higher winrates are preferable. I see a lot of talk of coinflips and high reward vs risk, but a high winrate with a small edge will perform better over time than a low winrate with a large edge. Why? Because risk is not equal, and the high winrate allows for a better risk-adjusted return. This is far more significant than most realise.
two thumbs up
  • #25
  • Nov 3, 2010 7:49am Nov 3, 2010 7:49am
R:R is an after the point fact. As a trader you goal is to trade your signals, get the best price, the best position size to best improve your equity growth. YES it is part of the planning process to have a clear understanding BEFORE you execute your trade where your SL will be, which governed with MM will give you your Position Size and also the most likely points that you are going to

1) Take full or partial profit
2) move SL to lock in BE or more profit

Having the forethought of I need to aim for 3:1 will not work as there will be situations that come into play that will have you manage your trade differently. For anyone saying they leave positions in play regardless of market behaviour because they HAVE to hit 3:1 or whatever it may be is either talking BS or doesnt care to much about the long term outlook ie They are expecting to make larger the normal returns.

I have for years now been working on the infinite yield theorem and can tell you that it is near on impossible to do, watching large or proportionally good returns turn into nothing because you have some R;R expectancy. It is only after the fact that you can work it out. That doesnt mean that achieving the result is out of the ordinary. In fact you could just move your SL to lock in 1:1 from BE once the position moves to 2:1 and so on. If the market retraces back then you get your R:R based on that but that is about all you can do and that is trade management.

High R;R is limited, they happen very seldom so you in a sense have a lower win rate (another after the fact number that is thrown around and abused) where as the lower R;R are usually easier to attain as market moves naturally take less time to get there.

Plan your trades completely. Have in your mind the most likely places you are going to encounter trouble and have a game plan for slow market moves and fast ones. Once the dust settles and you work out your gain then you can see where that trade lies.

And one last thing, dont get too hooked up on the R:R because you have looked at historical prices and they have move 2000 pips from where you MIGHT have entered or from where you DID once enter. The old saying 'gee if only I held that trade I could have ...........' is a real black hole that will have you breaking rules and plans which usually leads to equity demise.

Take care of the here and now

RT
  • #26
  • Nov 3, 2010 9:51am Nov 3, 2010 9:51am
What I'm also trying to prove as a theorem is that if a system is not profitable at 1:1 including the cost of spread and assuming constant volatility, it is impossible to make it profitable by expecting 1:N.

In the end the only thing which one can optimise is the entry. I challenge everyone who thinks that he can exit better than random to use 2 * ATR as SL and TP as a test for the last 100 trades. This benchmark will show if you have an edge or not.
  • #27
  • Nov 3, 2010 3:18pm Nov 3, 2010 3:18pm
Quoting Sauron
What I'm also trying to prove as a theorem is that if a system is not profitable at 1:1 including the cost of spread and assuming constant volatility, it is impossible to make it profitable by expecting 1:N.

In the end the only thing which one can optimise is the entry. I challenge everyone who thinks that he can exit better than random to use 2 * ATR as SL and TP as a test for the last 100 trades. This benchmark will show if you have an edge or not.
even with a good entry ... exit is a part of it.. there is no edge with just entry and random atr based stop.. stops should have a reason.. not be a random number..

the only edge that would come from entry and random equal distance stop and tp is if every trade was in direction of IRD and the random distance from stop to trigger was wide enough so that interest payments would pay back spread + before it could be triggered...

random exits and tps are pointless exits should have a point.. aka price must break support and lower lows before exit..

tps are harmful as you are restricting profitability.. every trade should have the potential for 1:infinite r:reward

efficiency says that that risk should not be a % of account but actually a set number that was at the beginning a % of account but is fixed from that point on... this lowers the win % needed to be profitable increases efficiency which inturn narrows the edge required to draw profit over time..
  • #28
  • Nov 3, 2010 4:00pm Nov 3, 2010 4:00pm
The market absolutely doesn't care if you are 3 or 2 R in Profit. Why should I close a good trade at 3? Doesn't make sense.
  • #29
  • Nov 3, 2010 11:40pm Nov 3, 2010 11:40pm
Quoting Mr J
The situation in which we take the trade does not remain static. Not being able or willing to adjust as the trade plays out is a liability.

As for which R:R is best, higher winrates are preferable. I see a lot of talk of coinflips and high reward vs risk, but a high winrate with a small edge will perform better over time than a low winrate with a large edge. Why? Because risk is not equal, and the high winrate allows for a better risk-adjusted return. This is far more significant than most realise.

Yes, I agree with this. After en entry is executed, someone has to maintain his trade. If market changes, it okay to take profit earlier or even cut loss although price haven't hit our TP or SL yet.

I didn't say that good RRR is the only way to make money. That's why I said that "If the RRR is not satisfy you then don't take the trade". Which amount of RRR is satisfy you? It's up to you, based on your method.

I think the idea that RRR should be good in order to become profitable without taking winrate into account comes from fact that newbie trader tend to take profit too early and cut loss too late.
  • #30
  • Nov 4, 2010 3:36am Nov 4, 2010 3:36am
Quoting domino
even with a good entry ... exit is a part of it.. there is no edge with just entry and random atr based stop.. stops should have a reason.. not be a random number..
This doesn't make sense. If a good entry alone cannot have an edge, then how can it be a good entry? If the edge doesn't exist in entry, then it must exist in exit, so I ask you why you think the edge lies only in exit. I won't wait for a reply, as I already know that much of the edge lies in the entry, and I would say that's where most of it lies. The entry decides the size of our slice of pie, and the exit controls how much of it stays off the floor.

I do, however, strongly agree that exits should have reason behind them, and not be based on some predetermined arbitrary number.

Quote
efficiency says that that risk should not be a % of account but actually a set number that was at the beginning a % of account but is fixed from that point on... this lowers the win % needed to be profitable increases efficiency which inturn narrows the edge required to draw profit over time..

This is equivalent to me suggesting everyone walk to work because it's a more energy efficient method of transport. They'll ignore me, and enjoy an additional 2 hours of productivity.

If the efficiency difference between percentage and fixed stakes is the difference between being profitable and not, then that person is a poor trader. With a good edge, far more is gained by letting capital be compounded.
  • #31
  • Edited 4:10am Nov 4, 2010 3:55am | Edited 4:10am
Bill Poulos made recently a video which is a part of some of his commercial systems considering exactty this issue.

The main point is that it is wrong to consider the R/R ratio isolated with the probability of success.

The probability of a winning trade is lower if the Risk reward ratio is higher. It is as simple as that.

You are playing against the odds every time you use a high R/R ratio. And to play against the odds you need a solid system.
For example if you have a R/R close to 1/1 you can have a winner by chance, but you can have a winner because your system is correct.

But this is an extreme simplification. It is important not only the R/R ratio but also how big is the target and stop loss and does it match the expected volatility.

I think if you find a way to get a high R/R without damaging the Win to Loose ratio you have found the grail.

So naturally the trend following systems are using high R/R because the market is not random at high time frames (and high stop losses). It has internal long memory processes and it can be proven mathematically, by estimating the Hurst exponent.

But anyway those questions are really though and have to find their answer in every single case. Every single case has to be solved on its own.
For example when you have an expert and you run the genetic optimizer you can have several correct R/R ratio not just one. For me that is a good sign that the system is promissing. If a system has only one R/R, it is probable that this was a stochastic event.

The best solution so far found is to open several positions (or to divide a position it is the same). The best will be to put the stop loss to zero and have an unlimited R/R ratio while close the others at logical profit objectives generated at your system.
It is a real though to manage the positions while they are open. For example you can set the stop loss to zero when it is not good because of the current volatility. In fact a lot of the overall profitability depends also how you manage your open positions. You can have a great entry but if you do not manage well your position your profitability will suffer. Sorry this becomes a newbie talk.
  • #32
  • Nov 4, 2010 6:28am Nov 4, 2010 6:28am
Being a programmer I ran thousands of simulations of every exit one can imagine and I wasn't able to find a better one than a fixed TP, from a compounding and drawdown point of view.
If one is in profit 100 pips on a trade in any pair, the chance from that moment to move +100 or -100 pips is exactly 50% therefore I see no point in continuing the trade.Closing it means that the next trade with100 pips will mean more $$$ due to the compound interest.
  • #33
  • Nov 4, 2010 7:11am Nov 4, 2010 7:11am
Quoting Special One
Yes, I agree with this. After en entry is executed, someone has to maintain his trade. If market changes, it okay to take profit earlier or even cut loss although price haven't hit our TP or SL yet.

I didn't say that good RRR is the only way to make money. That's why I said that "If the RRR is not satisfy you then don't take the trade". Which amount of RRR is satisfy you? It's up to you, based on your method.

I think the idea that RRR should be good in order to become profitable without taking winrate into account comes from fact that newbie...
there needs to be justification within the win rate though. There is no point in having a 95% win, which is also another after the fact calculation, if 1 of those 5 losses in 100 has a devastating effect. High win rates are usually skewed to the very poor R:R which puts them hand in hand in a way.

I could have a SL that is never hit and provided my risk is very small then I could withstand long periods of drawdown. In the end if you have a 500 pip SL for a 100 pip profit at 2% risk then you have to be happy with a .4% (or there abouts).
  • #34
  • Nov 4, 2010 7:31am Nov 4, 2010 7:31am
Quoting Sauron
If one is in profit 100 pips on a trade in any pair, the chance from that moment to move +100 or -100 pips is exactly 50% therefore I see no point in continuing the trade.
If you talk about 10 pips it may look correct. But for 100 pips the chances are really not 50 %. There are long term processes out there. Anyway I won't argue.
  • #35
  • Nov 4, 2010 7:34am Nov 4, 2010 7:34am
Quoting Mr J
This doesn't make sense. If a good entry alone cannot have an edge, then how can it be a good entry?
a good entry would be the best point that is confirmed in wave compression that gives you the tightest stop with confirmation that allows you to put more capital at risk for the same amount of risk.. this inturn increases your profits.
Quote
If the edge doesn't exist in entry, then it must exist in exit, so I ask you why you think the edge lies only in exit. I won't wait for a reply, as I already know that much of the edge lies in the entry, and I would say that's where most of it lies. The entry decides the size of our slice of pie, and the exit controls how much of it stays off the floor.
no the exit and the entry are equal you cant have edge without the other the trade is pointless all pieces of a system should work together to give the best result.. since we are traders and a traders job is to accept and mitigate risk to the best of there ability to find the greatest reward for the risk accepted.. we find that efficiency is extremely important as efficiency increases we have a higher probability of being profitable longer with more steady trades or higher consistancy. We find efficiency in all parts of our systematic risk mitigation techniques, all things being equal entrys are as important as exits in which best best entry techniques and the best exit techniques raise effiency and create the highest risk adjusted reward senarios.
Quote
I do, however, strongly agree that exits should have reason behind them, and not be based on some predetermined arbitrary number.
This is equivalent to me suggesting everyone walk to work because it's a more energy efficient method of transport. They'll ignore me, and enjoy an additional 2 hours of productivity.
see the idea here is not to reduce productivity but to increase it.. in this case is really equicalent to carpooling if you live near another employee that works the same shifts as you.. you should carpool as it is more efficient you save money on gas, car mileage, repair work, oil changes, and etc. if you carpool and cut mileage usage by 75% or more.. you have the same production as you are arriving on time to work but... you have reduced costs and thus better strategy
Quote
If the efficiency difference between percentage and fixed stakes is the difference between being profitable and not, then that person is a poor trader. With a good edge, far more is gained by letting capital be compounded.
see the difference here Is I manage a fund and capital conservation is the highest priority and ability to last is extremely important.. my clients understand that by aligning as many efficiency increasing pieces to my risk mitigation techniques I am lowing the chance of them losing money and that is what is important its not how you can calculate growth on your calculator and try to hit compounded goals that makes you money.. its actual trader performance.. its risk adjusted reward on multiple levels through time.. 6 month period, 12 month period, 3 year period.. and the controlled leverage and expansion based on that risk adjusted reward..
the ability to expand into MORE positions rather than the same positions that you can increase you exposure to and increase profits without raising risk..
  • #36
  • Nov 5, 2010 1:17am Nov 5, 2010 1:17am
Quoting Razor_trader

Having the forethought of I need to aim for 3:1 will not work as there will be situations that come into play that will have you manage your trade differently. For anyone saying they leave positions in play regardless of market behaviour because they HAVE to hit 3:1 or whatever it may be is either talking BS or doesnt care to much about the long term outlook ie They are expecting to make larger the normal returns.


RT
Hi Razor,

so what are you saying is that the golden way is having a 3:1 or maybe 4:1 profit target with the exception to be able to lock in winners that have an RR of 1:1 as the market goes in our favor. If the market returns and goes against us we still have made a profit that covers our initial risk.
  • #37
  • Nov 5, 2010 6:42am Nov 5, 2010 6:42am
Quoting Wallboroff
Hi Razor,

so what are you saying is that the golden way is having a 3:1 or maybe 4:1 profit target with the exception to be able to lock in winners that have an RR of 1:1 as the market goes in our favor. If the market returns and goes against us we still have made a profit that covers our initial risk.
More or less yes. The biggest misconception in regards to win rates and R:R is that they become the central focus point and it is what gets numbers. How many threads start off with '90%+ Win rate .........' but fold due to poor results. Same goes with high yielding rates. High yields only happen maybe a few times a year and that is up to the individual to see how far they can push there emotional boundaries.

You can only take what the market gives you. You can go for high yields by:

1) Moving SLs to BE and leaving them there, forgetting them until a point where it has done it job. This has the drawback of potentially seeing large gains erode during major pullbacks

2) Taking a half position of at 1:1, much like the works done my Peter Crowns and Joel Rensink and leaving the SL where it is or moving to BE to lock in a % of profit. The additional range of the SL means you can withstanding the short term volitility before the trade moves in your favour.

3) Move your stop behind the most recent swing high/low and see if the market has a huge run.

Number 3 has the better short term gain while opening to the door for larger moves on full positions. Number 1 works well provided you dont hand back every pip, so take some profit at higher returns for equity growth and number 2 really only address' short term volitility and is associated with small pip risks on smaller timeframes.

All in all there is no sure fire way to get large gains. You can only be open to the opportunity which depends on your tolerances and my comments are aimed to inform that.

Take care

RT
  • #38
  • Nov 5, 2010 7:00am Nov 5, 2010 7:00am
I trade off of daily charts(taking in account the weekly and 4 hour chart, commonly known as MTFA) and usually only use a 50 pip stop. I will only enter the trade if it is at least 100 pips away from the nearest resistance. That is the bare minimum which is 2 to 1. However, most trades have potential to go 1000 pips which is great RR. I win about 80% of the time and average around 4000 pips a month. I guess the moral of this story is that daily charts will give you great RR when traded correctly.
  • #39
  • Nov 6, 2010 8:46am Nov 6, 2010 8:46am
A modern market approach consists in not trying to predict based on the gut feeling, technical analysis or even fundamental analysis.

The idea is to try to predict not the market direction but the market state.

1. Cluster the market states:

All the successful traders have in common that they try to distinguish the market state.
A common approach is to use the relationship between the time of the day in the forex markets and the corresponding volatility.

2. Appropriate Use of an adapted system for the period

So when a market state is identified it is necessary to use an adapted system for this market state.

Traditionally there are:

2.1 Intra-day Trend following system

A Moving average strategy is the archetype of those systems.

Neural nets perform very bad as a trend following systems (with some exceptions for Neural Nets specially tuned for those conditions).
Digital filters with genetic optimization do much better


2.2 Intra-day Range Bound system

Oscillator based strategy is the archetype of those systems. Modern oscillators appears to be much smoother but still all the oscillators shares a collinearity.

The neural nets perform well in those conditions.
Statistical indicators performs very well too. In fact the phase space is so big under such conditions that it is more appropriate to model it statistical instruments. The Bollinger bands as a rudimentary statistical instrument is a classic player in the Intra-day range bound systems.


2.3 Break - out system after a contraction of the volatility

Those systems are particular. For example a Neural Net cannot never ever predict a break-out in the forex market.

How to distinguish between those market conditions:

Well the obvious reason is practice, practice, practice and experience, experience, experience
The human mind and the human perception abilities are much more suited to distinguish those states than any machine. For example an image recognition, the machines are still not capable of doing it for now.

There are some methods and some new ones that will be covered later.

My opinion is that the human mind is appropriate to distinguish between the market states. We believe that when a market state is identified it will continue for a while.

Second we use statistical instruments and methods to help us.

And third once a state is identified we use the appropriate tested methodology. For me a tested algorithmic system appropriate for a particular market state outperforms the average human trader.

So we should not try to predict the future. Even if we try to predict this will destroy our capacity of observing. This phenomenon happens because we select and choose to observe only what conforms our hypothesis.

When the prediction is useful?

In fact the prediction is useful when you manage your position once the position is open.

Example 1: Trend prediction

You open a trade in a trending environment for example after a break - out. Your setup was good (a setup is a setup) and once your position is opened and the stop loss is returned to zero, your prediction game starts.

Now you are trying to predict the market, what is going on, what will happen in order to manage a position.

Remember, this is like chess game. Your little position can be like a spawn that can turn up to be a queen, when it reaches the end of the chess board. And in order to be a queen you have to push it forward. And as in the Chess a group of spawns have a better chance to reach their goal, to become a queen.

And vice versa as Glenn Neely observes even if you have a very good prediction capability this will not help you in your trading (even if you are right maybe your timing was wrong, or the stop was hit just before your prediction come true). You need a good setup.

Example 2:
You have a setup in a ranging environment. You buy at an oversold level. Logically you predict that it will reverse when it goes up at an overbought level. And this is prediction after you have opened a position.

Conclusions:
There are two types of trading styles. Those strategies have advantages and disadvantages.

One trading style is based on the prediction: Elliott wave analysis is the best example.

The second trading style is based on a behavior of the market with statistical tools: the price action setups are one of the best examples. For example a break - out strategy in a period with high volatility.

A third strategy is a mixed strategy between a behavioral and prediction. You use your setups as a behavioral strategy and try to manage your winning positions by a prediction strategy.

The advantage of the behavioral strategies is the good win to loose ratio.
The advantage of a prediction strategy is the good R/R ratio.

A mixed strategy tries to combine both.
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  • #40
  • Nov 6, 2010 2:14pm Nov 6, 2010 2:14pm
People don't realize that RR has nothing to do with your system but with the market.....

Exit should be based on expected market movement
SL is based on volatility of the market at entry
Everything else is just bad

Small SL will be killed with high volatility
And any exit without taking the market performance in consideration is a guessing game
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