I just read the money management lesson on BabyPips. I must admit, after losing $1,000 after gaining $700 in one week, I’ve been gambling all the time I’ve been trading. I suppose that’s why I"ve lost over $3K in the last two years.
In the article it discussed the Risk to Reward ratio. How can you achieve this ratio in trading?
You can achieve it by first setting it. Say your Stop Loss is 20 pips you need to set a Profit Target greater than 20 pips, say around 40 pips. That would be a 1:2 R/R. I personally use R/R 1:1.5 or greater.
Go to my thread :
http://forums.babypips.com/newbie-island/10812-joy-candlestick-trading-learning-experience.html
Page 33, post #325 …onwards.
Your risk to reward ratio can be found by dividing your take profit by your stop loss.
Anything less than 1 is a ‘negative’ risk/reward. Anything higher than 1 is a positive risk/reward.
To take it a step further though.
Lets say you only trade a 1.5 RR (or higher). So a 150 take profit, would have a 100 stop loss, or a 75 take profit would have a 50 stop loss.
How many trades do you need to win to be profitable?
Lets assume you will make 100 trades, and win 50% of them.
150 * 50 (winning trades) = 7500
100 * 50 (losing trades) = 5000
So your winnings (7500) minus your losses (5000) is a positive 2500!
Lets assume you still make 100 trades and win 40% of them
150 * 40 = 6000
100 * 60 = 6000
You break even, despite the fact you have a ‘losing’ track record
I seem to be the only person that doesn’t think that ought to work ^
a 20-pip s/l is surely twice as likely (at least) to be hit than a 40pip t/p? It’s twice as close to the entry point.
Imagine an extreme example:
s/l = 1pip
t/p = 100pips
So [I]if[/I] you win even a few out of ever 100 trades, you’ll profit. But in reality you’ll lose nearly every single time because your s/l is so much more likely to be hit than your t/p.
You can’t consider win:loss ratios as a seperate issue from s/l:t/p ratios.
Of course all that ^ is assuming random market movement. Successful prediction of market direction changes things, but the effect I mentioned here will still exert its effects
I have REAL TIME Risk:Reward right on my chart so I always know what it is.
I can also set a MINIMUM and if Ratio is below the minimum, it is in RED.
No doubt, extremes will always be bad. Setting a tight stop loss will always mean a greater chance to get stopped out. I wasn’t trying to imply that you should set a 1 pip s/l. Markets will fluctuate and that needs to be a big consideration.
I think you’ll agree making trades with a 5 pip t/p and a 100 pip s/l is just as bad. Knowing what your potential risk/reward is helpful as it lets you assess RISK.
Thanks everyone for your answers. This has helped greatly.
you’re not addressing my point though. Do you maintain that the relative sizes of s/l and t/p can have a favourable effect on your trading profits?
Yes I still say having a greater t/p than your s/l is a good thing for your trading profits. I was just pointing out that your example was an extreme and really didn’t do much to help prove your point against me.
If you want an excellent example of why risk/reward ratio’s should be assessed in trading… Here’s an excellent example why in this thread: 301 Moved Permanently
using an extreme example is a good way to illustrate my point. Let’s work our way back from it, then:
s/l = 1
t/p = 100
A win is 100x the size a loss, [B]but a loss happens 100x easier (at least) than a loss[/B]. Net result? Zero.
s/l = 2
t/p = 60
A win is 30x the size of a loss, [B]but a loss happens 30x easier (at least) than a loss[/B]. Net result? Zero.
s/l = 10
t/p = 40
A win is 4x the size of a loss, [B]but a loss happens 4x easier (at least) than a loss[/B]. Net result? Zero.
Does it make sense now? You can’t outrun it, fiddling with the s/l and t/p surely can’t have any effect on your profits (over a statistically significant number of samples, of course).
As I said above, this relies on random market movement (and we can consider the market to be “random” unless we decide to consider its patterns. And these coin-tossing experiments don’t.
Like I said before I invite you to read the thread I linked to.
Cheers.
I skimmed over it but, wow, it’s hard to read 
Can you refer me to a specific post or quote the key conclusions here? I see that he is testing various systems that are relevant to our discussion, but the thread is a damn mess
What Bazooko was doing is flipping a coin every day. Heads he went long, tails he went short on a pair.
He had 3 different accounts:
one using a 0.5 - 1 risk/reward (so 13 t/p, 25 s/l)
one using a 1 - 1 risk/reward (25 tp, 25 sl)
one using a 1.5 - 1 risk/reward (37 tp, 25 sl)
The idea was the coin flip essentially gives you a 1 in 4 chance of winning (2 different chances from the coin, and the market can move 2 ways, up or down). This means to win over time, since your ‘system’ for entering trades won’t benefit you, you must win through money management.
Each account started with 2000 usd, and I think he was playing ~1 usd a pip, but to be honest I don’t remember 
At the end of a 3 month period the account balances were:
0.5:1 - 1831.90
1:1 - 1632.82
1.5:1 - 1714.81
Before you yell at me for obviously being wrong stick with me.
The 0.5:1 account had about a 60% win ratio, to be profitable you’d need a 67% win ratio. So looking good there all you need to do is trade with the trend, instead of giving yourself a 1 in 4 chance of winning. The 1.5:1 didn’t fair as well, but this is decieving in my opinion. For the first 2 months the 1.5:1 account was out performing the other accounts, the market went sideways the last month, and that is where the majority of the losses were made. This is also what helped the 0.5:1 account pull ahead.
Now, I personally don’t like trading in a sideways moving market, its better to pick out the trends. However if you are going to pick out the trends, may as well grab those ‘extra’ profit pips.
On a complete side note. I had ran an experiement much like this, without knowledge of this thread when I was first getting into forex. I wrote an ea in mt4 that decided trends based off of 2 ema’s (much like the cowabunga system here). It would make a trade with a t/p of 5 and a s/l of 100 in the direction of the trend. I never was able to make it profitable over the long term. I tried most of the major currencies on 15 min to daily time frames. I couldn’t understand why it didn’t work until I stumbled upon risk/reward, I took it as my answer.
However, I didn’t try running this program with a t/p of 100 and a s/l of 5. So perhaps you are right.
I do trade only with 1.5:1 risk/reward ratios. I’m profitable so far, but that is only 2 months, so who knows maybe my downfall is coming
Oh and sorry for the wall of text.
Thanks for taking the time to type that out, dude.
I think that should still be a 1 in 2 chance of winning: there’s two options and you’re going to pick one of them basically.
Anyway, there’s some interesting points there:
if you had 1:1.5 risk/reward (37 tp, 25 sl, you said) and the market was strongly trending then it will favour one direction of trading, of course. Let’s say it’s a bull market, then “every” time your coin toss says to go long, you will win it, and “every” time your coin toss says to go short, you will lose. It’s not every time but it’s skewed in that direction, you know what I mean.
In that case, the trend of the market could be strong enough to make it very unlikely for a short trade to succeed, or for a long’s stop-loss to be hit. With a tp bigger than a sl, you should profit, therefore.
But, in a ranging market, let’s say it flows up and down over a 100-pip range every day. If you’re at the top of a wave and you go short, you might win. But if instead you go long, you’d lose. And [I]vice versa[/I] at the bottom of a wave. At points in between, being stopped out or hitting your tp would depend where on the rising or falling surface you were. In this case, as in “random market movement”, the sl:tp ratio wouldn’t do anything to help you, I think.
So after decoirs common sense arguments over RR. I decided to take some time and do an experiment like bazooko’s.
I made an EA that would randomly make a buy/sell once every day over 2 years (2006-2008)
Stoploss was 50 pips, so a 0.25 RR means 13 TP and 50 SL.
I personally was astounded by EUR/USD 0.5 RR
Also for anyone that would like to repeat/test my experiemnt, I’ve included the mt4 EA I was using. (I pulled the random number arrays from matlab b/c I couldn’t get mt4’s rand generator to work properly)
Sorry, did you mention the results there or not?
The pdf has the results…they are in bold…
hmm, interesting. If is no trouble to you, maybe you could increase the number of samples from ~700 to many 1000’s?
Nope.
That is why I left the mt4 EA there to empower anyone to expand this experiment to suit their curiosity.