Risk & Reward vs Money Management

Hi there.

I have recently been involved in a thread debate/discussion/argument about a guy who posted signals free on a blog. I will not mention the blog, nor the guys name as that isn’t the point of this thread.

As with all heated discussions, after everything has died down, you begin to analyse everyones point of view to that argument in order to establish if you can learn anything from it…
What i have been left with is a question, that i believe is very pertinent for us traders.

I have always been of the opinion that money management matters more than the risk to reward ratio of any trades you take.

The reason for this is perhaps my style of trading which in a nutshell is to follow a trade until it turns against me. It goes alot deeper than that obviously, but in a nut shell if i get the direction right i will stay in it as long as i can, taking profits along the way.

I understand that alot of people have particular profit targets in mind when they trade, and aside from technical analysis, this can be purely a Risk/Reward thing “I risked 50 pips, i wanna get 100 pips”. 1:2 Ratio, makes it worthwhile for me to enter the trade.

Now my view on this matter is that each trade should be subjective. That is to say, you trade what you see at the time.

For example i enter short on a pair, my initial target (on my system) would be the bottom Bollinger Band, with the option of taking that trade (should price hit my target) to the next higher timeframe, and basically chasing the movement with some sort of trailing stop.

Heres where it gets interesting…

Say you put in a firm target, you entered short at 100.50, you set your target at 100.00 with a 25 pip stoploss. this would be a 1:2 Risk/Reward ratio right?
You set your pip amount to the maximum possible for your equity/margin…say $5 a pip. That would give you a �125.00 worth of risk (stoploss) for a potential $250 of profit.

Now,

Say that trade was set as a Take Profit, at that price (100.00) yet the price kept on going down…past your target for say another 250 pips. You are out of that trade with profit at your set target, but haven’t completely maximised on that movement. So you have your $250 of profit…but no possibility of getting anymore unless you enter again and risk the position going against you.

Now lets say you didn’t risk your maximum amount per pip, you only risked half (i wouldn’t do this am just using it as an example) so $2.5 per pip.

You set no target as your’re planning on following the movement until a significant change in price direction…you can afford to do this as the risk on your margin isn’t so high as the prvious example.

So you enter $2.50 a pip at 100.50, stoploss the same 25 pips @ $2.50 a pip so $65.5 risk.
The price drops like a stone, past 100.00, down to 99.00, 98.00 to 97.50 then begins stalling, it looks dodgy, stochs/macd are oversold, price you get out. You make 300 pips on $2.50 a pip so $750.

Now what has made you the money?

Is it the Risk/Reward…or is it the money management?

My point is that i find risk/reward a bit of a handicap…should you stick to your R/R ratios or should you trade the price as it is happening?

I would go for the latter.

I know that is a basic summation, i am sure there is more to come, but i didn’t wanna scare people away with a huge first page!

Am interested in everyones opinions in this matter.

As a side note, please don’t get aggressive on this thread, we are adults, we are here to help each other…and frankly i had enough of that in the last thread.

Let’s be constructive ok? :smiley:

Best of luck to you all.

I think it is meaningless for people to set an arbitrary R, as you say you have to trade what you see. Having said that there needs to be enough potential in the trade (however you assess that) to make it worth taking on in the first place and I think many traders overlook this issue. Lets face it R is only one of a key number of variables that you need to be aware of in evaluating your approach. Win/loss ratios and maximum drawdown are essential either for evaluating a system if that is how you trade or evaluating your own performance if your approach is more flexible

Glad you got in on this tony as i have always valued your opinion.

I worry about targets people come up with, specifically those based on static levels. I think it can be constricting. Especially to a noobie trading high on margin to make money quick.

You are absolutely right that R/R is only [I]one[/I] thing you should be looking at and that the potential for a trade is important…but what if it goes wrong?

What will protect you more? R&R or decent money management?

Isn’t propper money mangement a kind of R/R in itself?

If you trade maximum margin with 1:2 ratio, 1:3 ratio or even 1:4 ratio all you need is 2/3 trades to go against you and your account is in trouble. Which with a static target is possible (How many times have you seen price come to within a few pips of your TP only to reverse?)

Whereas if you trade a small % of your margin, even with two or three trades going against you, you could still be in the running to catch a major move that has the possibility to replenish your account because you follow the price and not a static r/r target.

I have been trading live for ages, and i always thought i knew the answer, but i have to admit, thinking about it, this has got me curious.

Both have their pro’s and con’s…but no two things are always equal, so one of these things must be more significant than the other…and hence more profitable.

look I agree with you. I have been progressively reducing my per trade risk as my approach has improved the key variables I mentioned. Any trade I enter now will have a 0.25 - 0.5% risk depending on how I assess the overall market and a leg up further into the trade is only after that first portion is safe. Overall MM is the key variable to longevity. I would need something like 40 successive losing trades to be out 10% or so of my initial starting figure and by then I should have rumbled that something is up!

if you think about those aspects of the trade that you can physically control & direct, then you have your answer right there.

the most important part of the process is control.

if you lose that (at any stage of the game) then your odds of long-term success are dramatically reduced.

so, which aspects of the subject matter you�re discussing here do you have absolute & total control over?

when you got that nailed down, you can begin to hone & shape your plan/strategy to take advantage of both aggressive & passive price action plays.

Risk/Reward only really matters if you have a trading approach which clearly defines entry and exit points. For example, someone who plays support and resistance or ranges can apply R/R. If you’re a trend trader trying to get on and ride long moves, though, R/R is of no use, except maybe from a broad overall measure of your performance.

I agree I think risk/money management is more important than strict risk reward ratio and TP points. You’ll get much further with trading, by trading not to lose money currenlty in your account and trading not to lose money you’ve made on good trades.

I’m sure there are traders that have strict risk/reward ratios and TP points and do well.

But, myself I’ve found I do much better by resetting my Stop loss to break even or positive as soon as possible, rather than keeping my initial SL in and holding on to it until my TP is hit.

That way, the following three occurances happen much more often than a losing trade: Break even = 0 pips but I didn’t lose anything. Hit my TP. Or have no TP, and keep resetting my SL to postive.

( I am a day trader, not a swing or long term trader how holds for days and months, I am in and out of between 1-5 trades in one day.0

The last of the three is how you deal getting stopped out postive and not being able to get all of a big move. You simply keep modifying the stop loss to positive. Much better than trying to jump back in and having to play the spread or commision again.

If you want to do the above and keep it more in line with risk reward, then as soon as you’ve hit your ratio, reset the SL to postive. For instance if you have a 1:1 ratio and your SL is twenty pips, as soon as you hit +20 pips or beyond reset the SL to +20 pips.

If I believe that price is going where I think it will, I usually set my SL to break even and keep it their until I get much closer to my TP, that way, sudden price movements don’t take me out at breakeven. If I think the direction could go either way strongly I reset SL to breakeven as soon as I can and either get stopped out or keep riding and resetting it postive as much as I can. You can get some really nice pips this way and quickly eliminate risk out of the trade. If you get stopped out at breakeven though, take step back and revaluate, so that you dont’ try to chase price.

I think Risk/Reward are best used as, “what if,” best and worst case scenarios, and not hard rules.
The initial SL, ya, in most cases that should be written in stone. But, thinking your are going to always get x amount of pips because your ratio dictates that isn’t going to happen, the market will let you know how many pips you can take. So, take them as they appear by resetting the SL to positive and locking them in.

I find absolutely nothing in “risk/reward” that has any bearing on how i trade.

money management is important, but with how i trade, even that gets stretched FAR beyond any good advice given !

with time, one SEES a good trade as its happening and so jumps on — there is NO time for figuring what the “risk/reward” may be so i call my accountant and have her figure it for me (NOT !)

i take profit at every reasonable resistance point (assuming a long) even if i know the ultimate tp point to be much higher, because there will be reversals all during the runup, like GJ today (and prob others, but i was in GJ) and i want to be able to have a full profit from resistance to resistance, and still be able to short the downside as it comes.

Often i will open multiple lots, taking different tp points as i read resistance on the timeframes, but whatever is happening, i NEVER would consider asking myself "is this a 2 to 1 trade, or a 3 to 1 trade or any of that ratio nonesence at all.

One would think that a guy who trades with NO stop loss would care about risk, but trading with the trend kinda eliminates that problem as long as i watch and listen to my resistance points.

for newbs, i havent an answer because like stop losses, ive never used any of that stuff and for the experienced traders, who know what theyre doing, ill bet many dont use sl’s at all either !

btw, while it certainly eliminates any “sl hunting”, NO NEWB should consider what i do to be something they want to try because it takes a bit more experience and knowledge than youve got at the moment, so DONT TRY THIS AT HOME !

anyway, not a lecture about sl’s but simply that i saw a post that mentioned risk/reward and stop losses in the same sentence, so i wrote a few hundred based on that.

enjoy and trade well

mp

[I][B]Within the great hall at Elfinore stands a wondrous coffer, precisely four cubits square and securely latched against the outside world. Inside that repository, shut away from impertinent eyes, abides many an intriquing trading secret garnered from around the world and over the ages !

As a child, i used to watch from the darkness as the secrets were debated and annotated by the elders. No one there held a single thought of my presence – BUT I KNOW WHERE THEY HID THE KEY !!
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