Risk / Reward - new approach

All over this forum we hear about having a good risk/reward. For example 2:1 or 3:1.

Makes sense I guess, when we enter a trade we might not be right, hence we wanna bank 2 or 3 times what we might lose. That way as long as we're right around 50% of the time we come out on top (just).

I don't like that thinking. Looking at it from a probablities point of view I think we should treat r:r differently.

Here is how I see it:

At any given point in time, price has a 50/50 chance of going up or down - now yes I know this isn't strictly true, but noone can predict exactly when a massive strong trend will end. Like I say from a purely probabilities based view, price will either go up or down.

Ok, so now we know that. Tell me what is most likely to happen. Price moves in one direction by 20 pips or by 60 pips? Doesn't take a genius to work out that price will move 20 pips much more often than it will 60 pips. Do you see where this is going?

So as convention has it we place our SL at 20 pips, TP at 60 pips. Can you see the problem with this?

My approach is to let my trades have room. Noone can predict exactly when price will move up or down in a strong move. Once I get +15 pips I move stop to b/e+1. But when I initially open the trade I might have a stop of say 40 pips (never more than 2% of my account though). My TP is normally around 20 pips or so. A lot of ffers here will say thats an awful r:r. On paper yes, but using my trading method I have confidence that 40 pips is enough wiggle room for my trade before it moves into +ve.

So thats why I do not agree with the r:r spoken about on here by many.

Just my opinion and thoughts, each to their own

Any RR ratio less than 1:3 should not even be considered. If you use a 40pip stoploss, you had better be aiming for 120 pips of profit. This is the only way you can survive in this market....And that's a fact.

Not fact, your opinion. Many would disagree and rightly so

Thats not a fact, I know several people who have R:R ratios that are less than that but they still make good consistent money.

There's no holy law in the market that says 'Thou shalt not having a target that is less than 3 times your stop'.

Even if relationships like that did hold, they would likely change over time.

You're making perfect sense. In fact IF price had exactly 50/50 chance of going up or down at all times, then - over a theoretically infinite number of trades - win rate and RR would operate in exact inverse proportion to each other, and every trading method would have an expectancy of 0 (disregarding costs).

I don't know what a typical SL is - all depends on time frame. For argument, say its 30 pips for a day trade. You will need to be damn good/lucky to get 90 pips consistantly. Much more likely that you will be stopped out before a big 90 pip move.

I certainly mean no offense, but personally I think that this type thinking (that everything in trading is to be broken down into nice and neat mathematically derived packages so you don't have to put any thought into it) is what causes so many traders to be unsuccessful, or at least not as successful as they could be.

It is not realistic to expect every trade to give you 120 pips profit, unless you are very good at deciding which trades to enter and which to leave alone. I have talked to people on this forum that are 70-80 pips up, but are looking for that 100 pip take profit scenario, and hold on until they wind up just breaking even. Because they are "taught" that you need a high R:R to be profitable, rather than just you need a profit to be profitable.

Traders need to realize that a whole LOT of money can be made on smaller pip trades. The idea is to make positive pips as often as possible. If you get into a trade and the next thought is "Well, let's see what happens..", then you need to work on your trading method, not money management skills.

I feel that it scares many traders to think of a SL as the "risk" of the trade, and the thought that they must have at least 3 times the SL as the profit target causes them to have difficulty reaching the target, or it makes them reduce the SL so they can get the profit target to a more reasonable number...and that results in being stopped out more often.

Perhaps it is better to look at a SL as simply the most you can lose if a trade goes terribly wrong....because you only get into the trades that have the highest probability of going your way, right? So think of it as a safety net. That may help put the profit target more within reach, and easier to manage emotionally, so you may feel okay to get out of the trade at 30 pips profit rather than waiting for 50 pips.

I don't use a SL in the traditional sense, I use one for emergencies (set at 100 pips). Now, certainly, I will get out of a trade as soon as I feel it is not going as planned, but my normal take profit target is 10+ pips. Mathematically, a 100 pip SL and a 10 pip TP is saying I am risking 100 pips to make 10 pips.....but that is not the case. Knowing that a trade may need to "breath", it is not unusual for the price to go against me 15-20 pips, but if the trade is still a sound trade, I may add to my position at 20 pips down, because I am still confident it is going to do what I expect it to do. It is that confidence that makes the term "risk" not have the same meaning as it does to many other traders. Am I ever wrong? You bet. But it ends when the trade is closed out.

I suppose this philosophy has been brought over from daytrading options, where the most you can lose is the cost of the options. But you better have confidence in your decisions, because when you trade 100 contracts at a time, you may have $10K-$80K riding on a trade. That is also why I bring over the small profit target concept. Trade 100 contracts, a $0.10 move in the option price is $1000 profit (minus commissions). Much easier and safer to get a $0.10 move than a $3.50 move....same with currency....much easier and safer to make 10-20 pips than 150-200 pips (for me, anyway). And again, you can make a great deal of money off 10 pip trades!!

I guess I said all that to say that I don't think that trading can be summed up into a tidy little toolbox package. And mathematically derived rules are not always the best, although they certainly seem to be the ones tossed around the most. Traders need to learn to think for themselves and not just feel that if they follow specific rules (minimum 1:3 R:R, no more than 2% on a trade, etc.), pay thier dues (blow 3 accounts, demo for 3-5 years, etc.), and follow arbitrary guidelines (10,000 hours screen time, $10K for mini-account, etc.) they will eventually be successful.

Okay, I'm done...carpal tunnel setting in.....

if a book tells you that you have to have a high RR>2 should you belive that?
rather than listening to an idiot speak do the math first. first of all when designing a trading system you have to have 2 parameters Risk/Reward and Win Rate. ok , let's go to some extremes first:
1. 80% win rate with Risk/Reward 1/0.75 . is this a profitable system? do the math and you will see that it is. profit in 10 trades is 4 points.
2 40% win rate and R/R 1/2.5. is this a profitable system? if you do the simple math you would see that it is. profit in 10 trades is the same : 4 points.

in my experience you can design systems with 40% , 50%,70% win rate but the higher you go in win rate the lower you have to go in risk/reward.

AS far i see risk reward with 1:3 is always good ..even if u get 50% hit rate of it u would be making millions of money ...as far i see those things comes with basic technical knowledge but does not come always ...so we have to make some own rules ..the things which works for you does not work for me ..The one which work for me does not work for you...

Anyways unique concept is more valuable than copying concept ..

If you are unique on any things from business dance etc ..everyone will appreciate u as well as you will get good reward ..

So am not trying to create my own rules for 1:2 atleast ..

Deltatrade is correct. If you traded with 15 TP and 40 SL, you'd have to win 73% of your trades just to break even. Tall order for any system.

The benefits of compounding gains is well-known. What is not well-known is the benefit of increasing your win % while keeping your r:r equal. For example, if you can take your win rate from 60% to 65%, you can increase your leverage by a factor significantly greater than 5%. How do you do that? This is where you should be focusing your studies.

You are kind of right in your thinking. Price either goes up or down and with no further information, if our R:R is 1:1, we will win 50% and lose 50% (minus spread)
If our reward:risk is 10:1 theoretically we will lose ten times as often as we win, and if it is 1:10 theoretically we will win ten times as often as we lose. In all three cases our net expectancy is zero, as Hanover pointed out.

However when we add certain filters to our trading we can change those statistics slightly creating small edges, and if we are good enough we can stack several small edges in our favor. The goal of trading is to trade a system which, for example, wins 50% of the time with a R:R of 1.5:1, or which has a R:R ratio of 10:1 but only loses 6 or 7 times as often as it wins.

The two ways to trade profitably therefore are:
1) to increase the winrate without reducing R:R, and
2) to increase R:R without reducing winrate.

You are claiming that one is no more difficult/easy than the other, I disagree. The overwhelming majority of profitable traders become profitable by increasing the R:R, not winrate. This is because of the kind of filters they use to change the probabilities of their trades - filters such as long term trend factors, support/resistance or lack thereof, fundamental drivers and techniques such as cutting losses/letting winners run, and building on winning positions.

These filters and techniques can all be used to increase R:R without reducing winrate, much easier than they can be used to increase winrate without reducing R:R.

This is why most successful traders insist on having R:R of at least 2:1.

I like your style I am completely on your wavelength moneymaker2. Like you, I go for the small pips, normally anywhere between 15-40 pips. I have my TPs either at round numbers (.00 or .50) or at pivot levels. Small gains compound nicely over time. For example my 2 trades so far today:

+23 and +25 which gives me 2.7% profit on my account today. More than enough. Now those 2 trades each opened with a SL at 2% NAV which is my defauly max loss per trade, which equates to about 37 pips, which for my types of entry is plenty enough wiggle room for the trade. This avoids me being stopped out prematurely. The first trade today went -20 but I held it out and it reached my TP. As said before when my trade gets to around +10/15 Imove SL to b/e+1. If I get stoppped out I reassess the market. Most times once it moves that far it will then reach my TP.

I think its very important that you give trades enough space to move and also don't risk too much per trade. Had my stop been too tight today I would be down about 1.5% instead of up 2.7%

Trading isn't simple and I think having rigid rules such r:r does not help. You need to be flexible in your trade management.

If you can't achieve above 50% win rate with 1:1 RR, then don't even dream that you will come ahead with 1:1.01 or above. There's no edge in whatever you're using. Law of average will kill you and you're just wasting your time.

A good RR is delusional, stay away from them, and you'll get closer to profitability

I find thinking in terms of risk/reward deceptive, unnecessary and it hurts my trading.

I Just keep the risk to a minimum (near zero). I do not let the market go against me. Not at all. Period. And the reward is whereever the market takes me because I am only able to see "change", not how far the market will go. And why run risk? Why limit your gains? Sure, take some profits of the table but I see no reason to get out while the market is trending in my direction.

I look at change in the big picture (15 min , 5 min), zoom in (1 min) and look for change there as well, micromanage, have a certain expectation of what the market will do (quickly go in my direction), place my trade and if the market does not quickly do what I anticipated I clearly don't know exactly what's going on so I get out and wait for another opportunity. I might be correct on the direction but have to be correct on timing as well...so I wait for a better time.

If the market does what I anticipated I zoom out again and stay in as long as possible (as long as the big picture doesn't change)

Risk/Reward? I have no clue and I don't care. As close as possible to zero/unlimited!!

I do place a stop initially but this is just an insurance for if the platform freezes or something like that. I do not like to place my stop close to entry because I get lazy and will let the stop do its work while I often can see what's happening before the stop is hit. I can always get in again. It's just silly to let price hit your stop while you already know that what you anticipated did not happen because then not only you got it wrong, but you also have an unnecessary loss!!

Getting out if the market does not do what you anticipate is something different from the market going against you and incurring a loss, then you're too late. The trick is to make a little money or BE if you're wrong and make a lot when you're right. Of course accidents happen...and I might have a 1-2-3 pip loss occasionally but that's something to work on. I do not allow myself to lose money. Sometimes at end of day I am thinking about myself: "Pff my God..your trading sucked today"...then I check P&L and it's still positive or at the worst BE.

The market goes up if it cannot go down anymore and vice versa. So the signs are there in advance. I do not wait for the market to go against me, so Risk / Reward is nonsense to me.

regards,
Ivo

Interesting seeing different perspectives. I personally do not spend any time worrying about R to R.
My goal is to reduce the risk (exposure) as quickly as possible on each trade getting it into a free trade status.
I risk 2-3% per trade though I may have 10% of my account exposed at any one time (5 trades X 2%).

I do this by entering each trade with 3 units. (3 micros or 3 minis or 3 standards depending on your account size)
I take 2 units at the size of my stop.

Lets say I have a 20 pip stop for this trade.
I have -60 pips of risk at the time of entry (3 units x 20 pips)
At +20 pips I take 2 units giving me +40 pips.
Now I have a free trade and do not need to move my stop (still have wiggle room!)
If I get stopped out I am still in profit +20 pips. (2 units at +40 pips minus 1 unit at -20 pips = +20 pips)
Otherwise I have banked +40 pips and have 1 unit to let run.
At some point I will start trailing my stop up but I let each trade determine when.

Currently I am using 6 units - take 4 off at amount equal to stop (free trade) and now I have 2 units to let run. This allows me to take 1 off at a higher profit and still have a runner.
I let each trade setup determine what stop is required.

This type of trade management keeps me in the "cut your losers and let your winners run" frame of mind.
As was previously stated, this works for me but maybe not for you........
Just my perspective.

Krmo

Just to illustrate the point in my previous post checkout attach.

Went long on 5th bar from the right. Everything looked good, 5 min, 15 minute. However, did not like the 3rd bar from the right...did not expect that. It's a reversal bar, pinbar, whatever you call it, that has to be confirmed by the next bar to be a reversal (basic candlestick stuff). I expected price to take me to a safe place. So I got out...with very small profit. Had price boosted up I would have stayed in and switch to the 5 minute so I will catch that next time. Had price reversed I would have been out so I will be out next time, hopefully also at a profit.

Had I already been at a safe place (entree 10 pips lower) then I would for sure have waited for that next confirming bar but because of risk management I just could not afford that. Entry was not good enough for that.

What actually happened in this case is that next bar was green which made the 5min close at BO and at its high obviously meaning "stay long".... However, I do not care about that. What happens in a particular case is not relevant. Just wait for the next opportunity.

regards,
Ivo

Hello Traders,

I personally believe that a R/R ratio bellow 1:2 could only work for a big noise(volatility) on Intraday Charts. And You need a win/loss ratio higher than 50% if You want to make some Profits.

If you trade on Higher time frames, (Daily, Weekly, Monthly), you need at least 1:2 R/R ratio with a success ratio of 50% or more.

On the other hand if you trade with progressive TP, why not use 50% of your Trade SL at a first key level, or support/resistence, minimizing your risk, and then put a conditional order few pips above the first SL price to re-enter the market? ... Just a Thought

To your success,
Doctortyby

I manage risk on position trades (most of my trades last a month or more) but the principle is the same on any time frame.

I ease myself into a position by taking several entries as the price moves in my favor and then averaging the position. Each new position moves the stop loss for all positions so by the time I've taken the fourth entry I am locked in profit on the first and at breakeven on the second.

When the trade begins I have no idea what the eventual profit might be (only the potential loss) as my TP moves with the trade, so R:R only has context in terms of backtest and historical performance.

The most important thing to know is your dollar risk (rather than pip risk) per trade (ie how far the stop loss is from entry price * dollars per lot per pip). Once you know that you can position size to manage risk (I use a very old fashioned 2% of nominal capital). This might mean that you size at ten lots when the stop loss is very close to the entry, and a tenth of a lot when it is far away. The really huge profits come when a market that has been almost flat suddenly goes ballistic (like the USDCHF did last week when I entered four positions in as many minutes).

In summary, it is the dollar risk/dollar reward that is the relevant ratio rather than pip risk/pip reward.

as my trading ways evolved i found out that risk reward is b/s

one assumes that we can predict how many pips the market might move for this particular trade, and well i generally dont use SL but this has been discussed elsewhere and im not willing to hear nor argue the soundness of this, so if you want to lecture me save it.

anyway, price is unpredictable but the prevalence in order assuming all things being equal give you a reason to trade in a particular direction. however, in my opinion RR is 50% price can always go against you or in the intended direction, and there is no analysis that can stop that.

hence a plan of what to do in these cases, is imperative, in my opinion a flexible approach is best for my trading.