Why we are taught to set risk/reward ratio larger than 1

[dnaj65000]

Originally posted by rezo_s
I took some time to illustrate the example I wrote about:

Interesting post and it makes sense. Too bad I didn't read that before going long EURUSD at 1.1686.

I drew some trendlines from the tops using the 1hr bar timeframe and it looks like the euro's broken all of them. Also, it's trading above the 200sma so that's my signal long. I'm currently taking trades based on my signals and didn't really think about the sideways channel. My stop is 35 pips and I have no target yet.

[rezo_s]

Dear Blusky,

So you say one should follow all the signals regardless the r:r ratio?
Dont get me wrong, I just want to understand what is the final point. As far as I understand, you say that if the trade is with the trend and you feel good about the trade potential, your wiggle tolerance is greater, and on shorter term traders its less; i.e. if you are with the trend, you have larger stops n targets and with shorter term trades you set tighter parameters? But still the point is that risk and reward (at least aproximetly) should be estimeted...stop should be set - that is for sure, right?

So the final point is that we should estimate this ratio before trades, and we should keep eye on it to be >1....or not?
May be I missunderstood something here, or did I get you right?

Regards,

[albion]

I think what blusky is saying is that he adjusts his risk depending on the potential rewards. And I would have to agree with this approach, risk is not a fixed variable.

Risk would obviously be lower near the bottom of a price channel, in which case if you pick a bottom and price goes against you you might be prepared to lose thirty pips, if however you are at the top of a price channel and price goes against you, you might only accept 15 pips.

Risk is also something that has to do with the amount of cash in your account. I have only allowed myself to lose maximum $300 on a trade (the buck has to stop somewhere) but I like to think that gives me a little leeway. If I am in a $150 loss and i think things are going to get worse I pull the plug, otherwise I hold on.

The thing I find most difficult is when to take profit, I generally am not that interested in a trade with less than $300 profit so that is my target initially (although I will usually look for trades that have more potential than this) Once $300 is reached I start to use a kind of percentage system, I will only accept a drop in profits of $100 until I reach $800, then $200 drop is acceptable

I would be interested if anyone else uses a similar take profit system or has one they can recommend

[mig928]

I look at risk/reward ratios as the effect of my trading. I never consider it in my decisions. Same goes with probability of wins and loses.

If I don't like the ratios, I'm getting then I change my system not my risk/reward ratio.

[Mongoose]

It is a statistically proven theory (though I accept that there are exceptions) that your win rate will always stray back to an average of 50% over the longer period.

Therefore, a system that has a p.f. of =< 1 will experiance a major drawdown at some point in the future.

I think that PART of "surviving" financially for a long time in the market is simply having a VERY high P.F. because you can withstand drawdowns.

As for "anticipated" profits, I have yet to see a system or person who can reliably predict the outcome of a series of 20 trades of more than 50% of the time.

Mongoose

[vikingtraider]

Originally posted by Mongoose
It is a statistically proven theory (though I accept that there are exceptions) that your win rate will always stray back to an average of 50% over the longer period.

Therefore, a system that has a p.f. of =< 1 will experiance a major drawdown at some point in the future.

I think that PART of "surviving" financially for a long time in the market is simply having a VERY high P.F. because you can withstand drawdowns.

As for "anticipated" profits, I have yet to see a system or person who can reliably predict the outcome of a series of 20 trades of more than 50% of the time.

Mongoose

Definitely agree at those numbers...

i'm trying very hard to get close to the 50% number

[eternalfuture]

Hello all,

As I read the thread, I see various ideas about r:r ratios and how to put the into practice.

I'm just sharing my thoughts, not trying to criticizing others.
I believe everyone has his/her own preferences about this kind of stuff.

As for me, after I analyze the chart and find any opportunities, I then setup the ENTRY, RISK, and POTENTIAL REWARD.

After setting it up, I look at it again. If the risk and reward ratio is < 1 then to me it's a good trade. If it's > 1, I skip it.

But even if it's < 1, I should take a look at it again.
What if the risk is 100 pips, while the potential reward is 200 pips?
It's 1:2, but I still don't like it, especially if my EQUITY is not supportive to 100 pips risk.
Thus if it's 100 pips vs 200 pips, I'd still skip it.

However, if it's 50:100 then it's worth trading because I can tolerate 50 pips risk.

Anyway, those are just my own view.

Surprisingly, the talk is about the ratio, not about adjusting it to the funds available.

Cheers!

[Mongoose]

If you are intraday trading, then and you want to get a high win rate & profit factor, then come up with a logical concept FIRST, then design the system around the concept.

For example, I know that there are a lot of Fibonacci traders in the market, so I look to exploit that and buy bounces off Fib levels.

I also see that people like to place orders at round numbers, I know that large institutions buy/sell near 10 or 20 sma on daily charts and so on.

As long as there is sound logic behind the method, the system will probably work.

If you get some wombat saying, "buy because the 3-amas are crossed up" then you know that they don't understand the first thing about trading because it simply doesn't work because there is no LOGIC behind it. The ama has no special money making powers, besides, intraday traders are NOT TREND FOLLOWERS.

In short, think of a concept, exploit it, demo it, trade it, become wealthy from it! It's very simple really!!

Mongoose