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question about my risk reward ratio

Discussion in 'Risk Management' started by Burns' Suit, Nov 21, 2011.

1. Burns' Suit

Hello All,

I'm having some difficulty wrapping my head around this and would appreciate some feedback.
To be clear I know how to calculate R:R, just not how to best track it as it applies to my trading.
Should I be calculating my risk every time at the price at which I place my stops. i.e. total risk. Or is my risk on the trade the max drawdown? Or the price I exit at if it's a loss?

Perhaps an example would help.

Today I had 4 trades each with 2 contracts (eight total). I had one winner and 3 scratch trades. On two trades I had an initial stop of 10 ticks. On the other two I had an initial stop of 15. A total potential risk of 50 ticks.
I'm usually shooting for 2:1, but if things are breaking down and I don't like what I'm seeing. I will often mitigate my risk by exiting one contract close to 10-15 ticks and letting the second contract prove me right or wrong on a risk free trade. So today, my 3 scratches were, \$0, -\$50, and \$40. My winner was \$387.50 or 31 ticks. Thus, giving me a R:R ratio of 1.55 with the winner since my stop was 10 ticks.

Should I look at this as I made 35 ticks today and lost 4?
Or should I look at this as I made 35 ticks today and risked 50?
I'm leaning towards the first one since It's not as if I factor unrealized gains as maximum potential rewards, so therefore perhaps I shouldn't worry about maximum potential risk unless it's being hit.

I'd love to hear what others do.

Thanks for taking the time to read and reply. I appreciate it.

2. ronblack

risk/reward = R/realized profit
where R = Max{initial risk, realized loss}

3. Burns' Suit

Hey thanks for your help. Just to clarify though are you saying Risk = whichever is greater between initial risk and realized losses?

4. braincell

I prefer to calculate it as

RR = Profit taken / abs(max drawdown during open position.)

This changes if you use cost averaging, but then again if you have the time (or a platform that does it automatically) you should treat each new open position for cost averaging as a new input for the RR calculation. Using max drawdown really tells you how bad it could have gotten and reflects the element of luck (in the time dimension) more accurately if you have a greater sample of trades.

I think most people will have slightly different methods though based on their preferences, and there are some which are a bit more complex too.

However i rarely use this calculation to calculate real risk over a longer period of time. It's all about how many trades you have to increase your sample size.

5. Burns' Suit

Thanks for your response braincell. It helps give me a better start.

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