The Smoke and Mirrors of the Risk/Reward Ratio | Forex Factory

Options

Go to
Permalinks
Print Thread

Similar Threads

What is your win rate and risk reward ratio? 62 replies

Rationale behind "Risk Per Trade" and "Risk/Reward Ratio"? 8 replies

Risk/Reward Ratio and the power behind account growth 15 replies

Risk Reward Ratio and Account Risk 30 replies

The Smoke and Mirrors of the Risk/Reward Ratio

  • #1
  • First Post: Dec 17, 2013 10:01am Dec 17, 2013 10:01am
Before opening a position, a trader needs to find out what the risk and reward ratio is. It is recommended that a good risk and reward ratio is 1:2 and a single trade must not risk more than 2 percent of total trading balance. It is a part of prudent risk management, or so the story goes.

The reason behind having 2 percent risk on a single trade is you will be able to trade at least 50 trades even if you lose them all in a row. Needless to say, this is not going to happen since you will be able to find out that you are not doing things in the right way. That gives you more chance to bounce back with an alternate, and hopefully better, strategy leading to improved trading performance.

Some traders use 10 percent risk on a single trade. However, to use 10 percent risk on a single trade for a semi-skilled trader (and that, for sure, is the category where you'll find me!) is way too high as far as I am concerned.

About 1:2 risk and reward ratio: the lower the risk-and-reward ratio the more chance you have to win them - that's the logic (this article is pretty ok on risk-and-reward and how to play it). Nevertheless, 1:2 is very achievable and this is the healthiest risk-and-reward ratio and is, accordingly, the one most recommended by experienced traders.

On the other hand, some traders love using 1:1 risk-and-reward ratio and they are quite successful too.

To sum it up, it is common sense to maintain proper risk-and reward-ratio and risk manage your trading style - you might win, but you won't lose as much. 'Course, there is no exact science behind it. But there's no exact science in science either...
  • #2
  • Dec 17, 2013 10:52am Dec 17, 2013 10:52am
how do you determine "reward"?

I can see how we can determine risk but the reward part is unkowable unless you know with precision where the market is going.
AVT INVENIAM VIAM AVT FACIAM
  • #3
  • Edited 11:49am Dec 17, 2013 11:36am | Edited 11:49am
I think a lot of people are mislead from R/R. In my opinion, R/R doesn't equal to Money Management.

1. When you open a trade, you don't really determine R/R ratio, because just as the_redlion mentioned, you wont know where the market is going. R/R will most probably provided by the system you use. When you get your trade setup, its either you choose to take up the trade or not, market doesn't stop at our risk/reward target.

Eg, if price can go up to 1.3900 and go down to 1.3600, does it mean you can only enter long if the price is at 1.3700? Personally I will still enter at between 1.3700 to 1.3850, because I know I still have 50-200 pips to make depend how much I am given and wait till I am prove the long trade no longer valid.

2. Even with good R/R, but bad winning percentage of a system, you may end up losing. So even you have a 2:1 Risk/Reward, but your winning percentage is above 80%, you make more profit, and have less psychological effect.

3. If according to conservative method of trading the lame 1% or 2% risk, I think most traders will trade on other entities instead of Forex. Personally, I will never use my 100000 to be deposit in Forex, and having my 98000 to rot in it not gaining anything. But why trade forex? High risk, High reward, tbh, spending small money to win couple of extra money is worth it, if one know how to control greed.

Eg, I compared my money invested in stock few years back, I had gained about 50% profit, recently it drop a lot, but it was never near 10% of where I enter. And I look back, if I took a wrong trade in a currency few years back with my money, I would have lost a lot of money today instead of sitting back with floating profit.

4. To stay in the game and preserve your account is, to minimize loss, and extend profit, but it's not easy. Sometimes one need to be daring to take risk, and also daring to cut losses. Said is easy, personally, I cant consistently do that too. lol.

Any way, just for sharing. Good luck all.
The only winner is the one who survive the longest...
  • #4
  • Dec 17, 2013 11:53am Dec 17, 2013 11:53am
Painstakingly calculating your RR when it is positive gives you that warm and fuzzy feeling that may you are onto something... only to be proven very wrong after the next trade or two.
RR was created by Mr. Tharp so that he could sell books and speaking engagements...
  • #5
  • Dec 17, 2013 11:54am Dec 17, 2013 11:54am
Quoting Mingary
Painstakingly calculating your RR when it is positive gives you that warm and fuzzy feeling that may you are onto something... only to be proven very wrong after the next trade or two. RR was created by Mr. Tharp so that he could sell books and speaking engagements...
yea, lol.
The only winner is the one who survive the longest...
  • #6
  • Dec 17, 2013 12:08pm Dec 17, 2013 12:08pm
Quoting the redlion
how do you determine "reward"? I can see how we can determine risk but the reward part is unkowable unless you know with precision where the market is going.
Maybe you just take your chances and set a TP 1-2x your SL. Maybe you have an idea of where price will likely get to before being hit with strong orders. Maybe you are taking trades based on reasons off the charts and are smart enough to forget focusing so much on a rigid R/R and more on cutting the losers short and riding the winners.
  • #7
  • Dec 17, 2013 2:00pm Dec 17, 2013 2:00pm
I think the 2% R:R is based on the strategy of: Some trades will win; some won't; so what . . .next. If you use it you shouldn't get yourself in to much trouble when you're first starting out.
Nobody ever went broke closing a trade in profit
  • #8
  • Dec 17, 2013 3:06pm Dec 17, 2013 3:06pm
Quoting kinspk
2. Even with good R/R, but bad winning percentage of a system, you may end up losing. So even you have a 2:1 Risk/Reward, but your winning percentage is above 80%, you make more profit, and have less psychological effect.........
I definitely agree with you.......
Markets are not efficient, rather they are effective - Jones
  • #9
  • Dec 18, 2013 5:21am Dec 18, 2013 5:21am
Quoting the redlion
how do you determine "reward"?
reward=(sum of the profits of each winner trade) / total number of winner trades

risk = (sum of the losses of each loser trade) / total number of loser trades

winrate = total number of winner trades / total number of all trades *100
"There's a sucker born every minute" - P.T. Barnum
  • #10
  • Dec 19, 2013 7:11am Dec 19, 2013 7:11am
Quoting Proximus
{quote} reward=(sum of the profits of each winner trade) / total number of winner trades risk = (sum of the losses of each loser trade) / total number of loser trades winrate = total number of winner trades / total number of all trades *100
that still does not tell you what "reward" you are looking at for this particular trade.

knowing the "reward" part of the equation means you know where the market will go, just because you would like the market to hit 100 pips, doesn't mean it will, s/l at 50 pips t/p at 100 is not 1:2 r/r its basically 50 pip risk : reward = ????????
AVT INVENIAM VIAM AVT FACIAM
  • #11
  • Dec 19, 2013 8:04am Dec 19, 2013 8:04am
Quoting the redlion
{quote} that still does not tell you what "reward" you are looking at for this particular trade. knowing the "reward" part of the equation means you know where the market will go, just because you would like the market to hit 100 pips, doesn't mean it will, s/l at 50 pips t/p at 100 is not 1:2 r/r its basically 50 pip risk : reward = ????????
Exactly.

every trade I make I have a target .the management part of trade allows for calculating risk to the trades reward ie the stop point.the markets volatility or I should say change in volatility can void my trade .new information can change this.but my initial trade starts of with the best entry point and a calculated exit point.
  • #12
  • Dec 19, 2013 8:55am Dec 19, 2013 8:55am
Quoting diceman555
{quote} Exactly. every trade I make I have a target .the management part of trade allows for calculating risk to the trades reward ie the stop point.the markets volatility or I should say change in volatility can void my trade .new information can change this.but my initial trade starts of with the best entry point and a calculated exit point.
I agree 200%. Especially with"new information can change this.but my initial trade starts of with the best entry point and a calculated exit point." Based on the balance of probabilities of the trade being positive more than negative
Nobody ever went broke closing a trade in profit
  • #13
  • Dec 19, 2013 9:31am Dec 19, 2013 9:31am
Quoting the redlion
{quote} that still does not tell you what "reward" you are looking at for this particular trade. knowing the "reward" part of the equation means you know where the market will go, just because you would like the market to hit 100 pips, doesn't mean it will, s/l at 50 pips t/p at 100 is not 1:2 r/r its basically 50 pip risk : reward = ????????
Yes but if you trade a mechanical system, your entry and exit will always be based on the same criteria, so you can look at the past profit and losses and average them and you have your average risk and reward values.

Note, this only works for mechanical systems, if you always change your entry/exit criterias then this will not work, but if you trade the same system over and over again this is a very powerful tool to predict what you can expect from your trades.
"There's a sucker born every minute" - P.T. Barnum
  • #14
  • Dec 19, 2013 10:20am Dec 19, 2013 10:20am
I think 'expectancy' is far more relevant when evaluating a strategy, as this takes into account your risk / reward and win rate. Once you have a strategy with a significantly positive expectancy you just need to take care of the money management side of things (e.g I do not with to risk more than 1% of my account on a single position) and you're good to go

E = (average size winner * %winners) - (average size looser * %Loosers)
Trade ideas posted daily with a follow up each night. See post #1
  • #15
  • Dec 19, 2013 12:03pm Dec 19, 2013 12:03pm
Quoting Proximus
{quote} Yes but if you trade a mechanical system, your entry and exit will always be based on the same criteria, so you can look at the past profit and losses and average them and you have your average risk and reward values. Note, this only works for mechanical systems, if you always change your entry/exit criterias then this will not work, but if you trade the same system over and over again this is a very powerful tool to predict what you can expect from your trades.
So what is the math you use, different than looking at support and resistance lines to see where price has been, to predict where price is going. Isn't what you're doing with your math the same principle as fib and pivot indicators do, just a different formula using past numbers to get an idea where price is going in the future? You could explain what you mean by past profits and loses? I'm not sure if you mean your past profits and losses and if not whose past profits and loses are you using? As you have probably guessed I'm not a mathematician but I thought in order for the numbers you use to be accurate, you would need a lot of them, so where do they come from?
Nobody ever went broke closing a trade in profit
  • #16
  • Dec 19, 2013 4:06pm Dec 19, 2013 4:06pm
Quoting gp00053
{quote} So what is the math you use, different than looking at support and resistance lines to see where price has been, to predict where price is going. Isn't what you're doing with your math the same principle as fib and pivot indicators do, just a different formula using past numbers to get an idea where price is going in the future? You could explain what you mean by past profits and loses? I'm not sure if you mean your past profits and losses and if not whose past profits and loses are you using? As you have probably guessed I'm not a mathematician...
I`m neither a mathematician and i`m not predicting nothing, i pretty much believe the market is unpredictable or atleast it requires very high effort to do it, and i`m not really into it at the moment.What i do is i only analyze historical data.

I use the only and most important principle of trading: "history repeats itself".Without this trading would be impossible, what i do is i look at my past performance at x given conditions and i can atleast put a probability to my claims.Its mathematical induction if you will, i have a claim and i try to generalize it to all possibilities.So my logic is that if i have a record of 1000 trades with an x outcome, and the criterias how i took those trades were constant, meaning the system was a mechanical or based strictly on rules, then i can pretty much assume that the 1001th trade will probably be the same.Nor certainly because there is no absolute certainty but probably, and because of that, its easy to evaluate any trading system and rule out the bad ones.

And yes, as more samples you have the more accurate is the data.So that is why a big backtest is very important to a succesful system.
"There's a sucker born every minute" - P.T. Barnum
  • #17
  • Dec 19, 2013 4:43pm Dec 19, 2013 4:43pm
Quoting Proximus
{quote} I`m neither a mathematician and i`m not predicting nothing.
Okay I follow. Makes sense
Nobody ever went broke closing a trade in profit
  • #18
  • Dec 20, 2013 6:40pm Dec 20, 2013 6:40pm
Quoting gp00053
{quote} Okay I follow. Makes sense
I took a statistics class back in college, and believe me it helps me out very much in trading too.
"There's a sucker born every minute" - P.T. Barnum
  • #19
  • Dec 21, 2013 8:19am Dec 21, 2013 8:19am
I'm glad it's working for you my friend
Nobody ever went broke closing a trade in profit
  • #20
  • Dec 26, 2013 1:28am Dec 26, 2013 1:28am
This whole industry is smokes and mirrors not just the RR rule but every god damn rule that is instilled in us by trading prophets, bucket shops, gurus, books and trading rooms.
Everybody looks for the holy grail that doesn't exist. RR will stop you going broke quickly. It will also give you severe stress when your position meets its pre determined target minus a pip or so and does the reverse on you.
Best play is simply bet within your budget. Take profits by a combo of previous structure S&R and/or gut feel....bank it and say goodbye till the next opportunity presents.
0 traders viewing now