The Famous Risk/Reward Myth
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If you have been trading or interested in trading for some time, I am sure you have heard some online "teachers" say that you MUST have a 1:3 or 1:5 R/R in order to be profitable.. That is absolutely FALSE! If you hear a "professional trader" say that, odds are they are not truly a trader.. A professional trader understands that R/R & win % are correlated. The higher the R/R, the lower the win %, The lower the R/R, the higher the win %.. Determining an appropriate R/R should be decided based on your strategies performance (derived from backtesting different targets/stop losses) as well as your psychology. In other words, R/R and win % should be viewed as one metric, as they MUST work together in order for you to be a consistently profitable trader. As for the psychology aspect- are you a trader who can lose 70 out of 100 trades so long as your making money? I personally prefer to win 60-70% of my trades but that decision is up to you. The important thing is that you balance these two metrics to ensure profitability while catering to your psychology to maintain confidence in your strategy. There is no right or wrong in trading, only what works and what doesn't! If you are not sure what Risk/Reward or Win % is, please see below-
Win %
Win/Loss Ratio also referred to as Profit/Loss Ratio
What Is Risk/Reward?
Risk/Reward is a used by traders to determine how much capital they are willing to risk in order to make a desired reward. For Example- lets pretend you are using a trading strategy that has a 1:1 R/R & you are risking $10 on each trade. A 1:1 R/R would mean that you are risking $10 to potentially make $10. Using this same example with a 1:2 R/R, You are risking $10 to potentially make $20. For a 1:3 R/R, You are risking $10 to potentially make $30 and so on. In order to successfully make a profit with a 1:2 R/R, the market has to move twice as far to hit profit targets than it does to hit your stop loss. In order to successfully make a profit with a 1:3 R/R the market has to move three times as far to hit your profit targets than it does to hit your stop loss & so on.. By default, the further price has to move to hit your profit target, the less likely it is for the trade to be successful, ultimately lowering your win %. With that said, it is important to note that a lower win % does not necessarily mean the strategy is more or less profitable than a strategy with a higher win %. Lets look at some examples below:
Looking at the examples above, we can see that both strategies made the same amount of money even though one strategy wins 30% of trades, while the other wins 60% of trades! Of course there are small variations to the examples above as not every strategy with a 1:3 or 1:1 R/R will have a 30 or 60% win/loss ratio however the overall concept stands and should be taken into consideration whenever developing or trading ANY strategy.
In my last tutorial- "Simple Patterns Tutorial, The Correct Way To Trade Double Tops" I asked you all to vote on which double top you thought would perform the best out of the 3 common double top formations shown above.. Each top received votes however, top # 2 received the most votes. The answer to this question may have surprised you however, it will be highly beneficial to your trading!
As always I hope this was helpful, the information shared in this educational post regarding risk/reward is an extremely CRUCIAL aspect of risk management and remaining consistently profitable so be sure to read over everything multiple times if need be. Please give this a thumbs up if it was helpful and you would like me to post more material regarding risk management. Also feel free to comment below or message me with any questions you may have.
If you would like access to a free position size and risk calculator that I personally use myself, please use the link below to request yours
goo.gl/forms/poie4UX3iJi6jn3I3 OR Visit tradersnsights.com/calculators-tools
Win %
Win/Loss Ratio also referred to as Profit/Loss Ratio
What Is Risk/Reward?
Risk/Reward is a used by traders to determine how much capital they are willing to risk in order to make a desired reward. For Example- lets pretend you are using a trading strategy that has a 1:1 R/R & you are risking $10 on each trade. A 1:1 R/R would mean that you are risking $10 to potentially make $10. Using this same example with a 1:2 R/R, You are risking $10 to potentially make $20. For a 1:3 R/R, You are risking $10 to potentially make $30 and so on. In order to successfully make a profit with a 1:2 R/R, the market has to move twice as far to hit profit targets than it does to hit your stop loss. In order to successfully make a profit with a 1:3 R/R the market has to move three times as far to hit your profit targets than it does to hit your stop loss & so on.. By default, the further price has to move to hit your profit target, the less likely it is for the trade to be successful, ultimately lowering your win %. With that said, it is important to note that a lower win % does not necessarily mean the strategy is more or less profitable than a strategy with a higher win %. Lets look at some examples below:
- Example 1- You are using a strategy that has 1:3 R/R and a 30% win %.. In this example we are going to look at 100 hypothetically trades.
70 losing trades at $10 each (70 x $10 = -$700)
30 winning trades at $30 each (30 x $30 = $900)
Net Profit/Loss = $200 - Example 2- You are using a strategy that has a 1:1 R/R and a 60% win %.. Again based on 100 hypothetical trades.
40 losing trades at $10 each (40 x $10 = -$400)
60 winning trades at $10 each (60 x $10 = $600)
Net Profit/Loss = $200
Looking at the examples above, we can see that both strategies made the same amount of money even though one strategy wins 30% of trades, while the other wins 60% of trades! Of course there are small variations to the examples above as not every strategy with a 1:3 or 1:1 R/R will have a 30 or 60% win/loss ratio however the overall concept stands and should be taken into consideration whenever developing or trading ANY strategy.
In my last tutorial- "Simple Patterns Tutorial, The Correct Way To Trade Double Tops" I asked you all to vote on which double top you thought would perform the best out of the 3 common double top formations shown above.. Each top received votes however, top # 2 received the most votes. The answer to this question may have surprised you however, it will be highly beneficial to your trading!
As always I hope this was helpful, the information shared in this educational post regarding risk/reward is an extremely CRUCIAL aspect of risk management and remaining consistently profitable so be sure to read over everything multiple times if need be. Please give this a thumbs up if it was helpful and you would like me to post more material regarding risk management. Also feel free to comment below or message me with any questions you may have.
If you would like access to a free position size and risk calculator that I personally use myself, please use the link below to request yours
goo.gl/forms/poie4UX3iJi6jn3I3 OR Visit tradersnsights.com/calculators-tools
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