I don’t intend this to sound “critical” or “caustic” at all, but it strikes me that discussing R:R ratios without taking both win-rates and trade-frequency equally into account is the same as looking at the potential profitability of playing poker for a living by looking at “how big the pots you win” are (compared with the ones in which you lose money) without also looking at [B]how many[/B] of them you win (not to mention how often you play).
What matters (given reasonable/viable trade-frequency that suits you) is [U]expectancy[/U].
R:R ratios are half of the expectancy calculation. The other half is win-rates.
Given equal trade-frequencies, you make nearly three times as much money with a R:R ratio of 3.0 and a win-rate of 40% as you do with a R:R of 0.75 and a win-rate of 70%. Does that mean that higher R:R ratios are better?
Similarly, you make nearly three times as much money with a R:R ratio of 0.75 and win-rate of 80% as you do with a R:R ratio of 2.8 and a win-rate of 30%. Does that mean that lower R:R ratios are better?
In several standard beginners’ textbooks like Van Tharp’s [I]Trade Your Way to Financial Freedom[/I], accredited authors explain why the practical realities predicate that in the long run, systems with lower win-rates are actually more likely to prove profitable over the longer term (it’s counter-intuitive, to many people, but it’s technically correct).
What they tend to overlook, to some extent, is that for aspiring (i.e. not very experienced and/or perhaps not very statistically/probabilistically sophisticated) traders, high win-rates - and concommitantly lower R:R ratios - are [B]far[/B] easier to trade, because with those methods, the potentially adverse impact of inappropriate position-sizing (to which such aspiring traders are particularly prone) is [U]significantly[/U] mitigated. It’s for this reason that I instinctively wince when I see people saying that “you need a R:R ratio of at least 2:1”.
My own background made this rather a surprise to me: I originally learned how to trade under the supervision of institutional and ex-institutional traders together with input from devouring what some people would consider “heavyweight” textbooks. It literally [I]never occurred to me[/I] that high R:R ratios could be an advantage. Much later, when I started looking at trading-related websites and forums - in other words when I started noticing internet “information” - I realised with some surprise that “most people” seem to think higher R:R ratios are a good idea, and regularly offer that principle as “advice”. I sometimes wonder how appropriate it really is.
(Edited to add: if anyone’s interested, the R:R ratio for most of the systems I use, myself, is [U]well[/U] below 2:1, and for many of them it’s below 1:1, and that gives me high win-rates, and a smooth equity-curve with low drawdowns. Drawdown sizes have always been [I]hugely[/I] important to me, because I’m [I]extremely[/I] risk-averse and see all trading as inherently being about risk-management rather than about profit-maximisation: if you have a genuine edge, know what you’re doing, and just concentrate on “not losing money”, then you’ll make a living. That’s my perspective. I accept, of course, that it isn’t everyone’s.)
