Risk/reward

[edacsac]

I've re-read the section in pip school and have been checking different threads and things about risk reward per trade. While I'm demoing, I've been setting my trades with a 25pip stop loss, and a 10pip take profit. I'm doing this to allow for movement. Now that I understand more, it seems I have a negative reward to risk ratio. Even being in the negative for reward/risk, it seem to make sense to me to have a somewhat generous stop loss to allow for drawdown that would increase for longer trades and be shorter for shorter time frames.

The reason I ask, I just received a call from a broker that I signed up for a demo with. He told me I'm doing the reward risk thing backwards. I disagree. If I've made a good choice on my trade, I shouldn't worry as much about a tight stop loss and should have room for draw down if I truly believe in my trade. If I use tight stops all the time, then a slight retracement or unexpected movement will knock me out at a loss before a profit could materialize. Shouldn't reward to risk be analyzed cumulatively at a later time as opposed to setting stops based on a ratio?

I guess this logic changes depending on the leverage you use as well. Having a higher stop loss then take profit at 10:1 is different then at 100:1. This particular broker offers 100:1 as the minimum. I don't know if I like 100:1, even though making a $1 on 10pips is certainly better than $.10. It just seems that larger leverages tend to influence tight stop losses as a trading plan because the loss is greater. On the other hand, I'm not doing so good in my first couple of days of demoing, as I'm hitting more stops than I am profiting. But thats just because I'm not making good trades yet.

Am I going in the right direction with my thoughts?

[rhodytrader]

Firstly, you shouldn't link risk/reward with leverage. They are seperate discussions.

Secondly, risk/reward should only be one part of the equation. Your trading performance expectation is based on two primary factors: 1) Your win%, 2) The ratio of the size of your average gain vs. your average loss. The latter is basically you risk/reward ratio.

If you're risking 25 to make 10, then your win/loss ratio is .40 (10/25). That means you must having winning trades at least 75% of the time to be net profitable over time (based on equal trade sizes).

[mtandk0614]

Yeah...your going the wrong way here.

Your logic behind the negative risk/reward is understandable. As you stated "if you are making good trades". But allow me to reverse the table on you...if you are making good trades, then your risk should not be lower than your target profit. Maybe easier to break it down like this:
If you have SL 25 and TP 10...........Balance of 100 just to make life easy:
If you really are "making good trades" a 70% win rate would be acceptable.
so you start with 100, with 70% wins.....you have profit of 70, loss 75....not good.

NOW...lets change the point of view and pretend the term "Making good trades" equals a 40% win rate.....should be easier to do...we hope.
I perfer a 3:1 or 4:1 ratio...but we will go with the min. 2:1.............
I have 100, SL 20 and TP 40. In the last 10 trades I win 40%.
Profit = 160, Loss = 120 ....YEAH !!! I am rich...ok not really, but hey I made some money.

If your system does not work with a 2:1 ratio....I would suggest you change your system. And if you find you are not hitting the target profit enough...try applying your system to a longer time frame.......Quality over Quantity my friend

Best of luck to you.

[rhodytrader]

Originally Posted by mtandk0614

If your system does not work with a 2:1 ratio....I would suggest you change your system.

Again, it's both sides of the equation that matter. Some systems have above 50/50 win rates, but low w/l ratios, while others have sub-50/50 win rates, but high w/l ratios. Expectancy takes both measures and tells you want you would make on an average trade. Use that as your measure and combine it with how often you get trade signals to know how good any system really is.

[mtandk0614]

Originally Posted by rhodytrader

Again, it's both sides of the equation that matter. Some systems have above 50/50 win rates, but low w/l ratios, while others have sub-50/50 win rates, but high w/l ratios. Expectancy takes both measures and tells you want you would make on an average trade. Use that as your measure and combine it with how often you get trade signals to know how good any system really is.

I agree 100%, as I stated below...based off the term "making good trades".
A trader needs to determine, for their trading style, if "making good trades" equals a higher or lower win %. Then based off that win % look at your target profit vs. the stop loss and determin what risk/reward ratio would be the best fit.

If making good trades, shows a steady win rate of 75% .... then 10/25 is fine. And if anyone is doing that...please show me how LOL
I am happy with 50% win but a larger risk/reward ratio.

As always there will be many views on each topic of trading...Read them, Try them, hopefully form your own method that works, then share so others may continue to grow

[randont]

Alot of good advice here. I'd check out the holy grail section and test run some of the systems. I totally get where you're coming from. The system I trade is a very high probability system but stops are huge also. Just keep at it you'll find trading very rewarding.

[edacsac]

I've been looking at some of the holy grail systems, but I want to stay closer to using mainly candlesticks as opposed to too many indicators. Right now I mainly watch BB's and MACD. I don't think the MACD really does me any good at the moment, but I see the value of BB's. I'll probably test a longer timeframe system out soon, since I haven't ventured out of the 15/30 minute charts yet.

But anyway, I'm finding that solid examples of any good reversal patterns are few and far between. Some of the chances I've been taking have been what I like to call "struggling ascensions", where resistance is being broken but barely. Even though the price closes higher as the middle BB is approached, the bottom wicks are very long - which forces me to make my stops big. But I'm not being greedy. My t/p I usually leave at 10, but sometimes I see a need for 30 or more as a s/l, because of the long bottom wicks.

[mojo6911]

I just started here, but it seems pretty basic to me. If you are making good trade, you still have it backwards. You are limiting yourself to only make 10 pips, but stand to lose 2.5x that. You want to maximize the gains when you get them (good trades) and minimize the risk when you screw up.


Lets say you are a good free throw shooter in basketball. I will pay you $10 for every one you make and you will pay me $25 for every one you miss. Even if you build up your bankroll to $100 by making 10 in a row, you could easily lose it all with 4 missed shots. You may be able to win in the short term, but long term, you can't sustain a win rate that high.

[edacsac]

I see your point, but I don't think it's that easy. I decided to adjust my stops to reflect a better per trade risk. So I browse through the list of pairs and settle on a AUD/JPY trade. Looking at the H1 and M30 charts, I decide to go short. I figured I could get at least 25 pips out of this and my gut feeling (or whatever you want to call it) tells me to do the same for a s/l, since I think the uptrend is running out of steam, but there still may be some upward movement. Under the popular logic, thats still not a good move, so I move my s/l to 10pips. Per the attached picture, I got stopped out twice to only find later that things carried on like I had thought they would in the first place. If I would have gone with an unfavorable s/l, I would have made 25+ pips.

So basic to you or not, you would've been wrong. Just like I was by lowering my risk and going against what I saw in the chart.

Do I really have it backwards? If I would've left it backwards, I would have gained. Maybe this is just an isolated incident and over time I would lose more, but as I have time to practice, these are the type of trades I'm picking. No real poke you in the eye indicators, but some redhead stepchild quality chances that may require some drawdown to realize anything.

I'm sure once I pick up on some more solid oppurtunities, I'll be able to use tighter stops.

But thanks for the input!

[akeakamai]

Your stops and targets should relate to the volatility of the market. A 10pip s/l doesn't relate to the volatility of the 30min AUDJPY very accurately. I would recommend a s/l of about 25pips, but also shoot for about 50pips too.

I'm guessing you feel your method is better because you undoubtedly "win" more often than you lose. But winning more often doesn't mean you will be making any money if you are risking excessive amounts to get those winning trades.