Risk/Reward Question

Discussion in 'Risk Management' started by Rashid_G., Feb 5, 2010.

  1. They say you must know your risk reward before entering a trade.. The risk part is relatively easy to figure out.. In this case anything outside the 1737 to 1744 box defines risk (of course with size factored in). Thinking long over 1745, what is the potential reward?? 1747 to 1750 "looks" defendable by the shorts but we all know how quickly that can change.. In fact since we "shouldn't" be forecasting and knowing anything is possible how do you calculate reward.
  2. JeffUSA


    I've been wanting to start a thread regarding risk-reward ratio.

    Unless I am misunderstanding it, how can we consider a risk-reward ratio a valid tool, if the reward part is theoretical? The reward part hasn't happened yet since it is in the future. Since the reward is theoretical (and maybe even a highly educated guess based on Technical Analysis) how can we rely on this?
  3. Jeffp


    Real simply, if you want to get in a trade , decided where your stop would have to be according to market structure , sup/res...etc. Find the difference between entry and stop and multiply by the risk reward ratio you're using, typically 1:3 for me,

    So 3 times the difference then see if the market has the potential to deliver that 3x given the prevailing market structure and or conditions, event risk... etc.

    If you're using I high probability strategy, say 75% + then your risk
    reward can be closer 1:2 or maybe 1:1. Depends on the stats for your strats!

    Also I don't risk more than 1% total equity for a stop on any one trade...so that can kill the trade before I even get to multiplying the reward.

    So consequently I'm waiting for the trade to come within my account's basic risk limits...this often gives me a better entry...instead of jumping in too early with too much risk.
  4. The success rate, risk/reward ratio and profit factor are related by a neat formula. It is worth reading the first 7 pages of this paper.
  5. Considering I am currently all in or all out I have decided simply to focus on the risk side so no R:R calculations for me. Now if I used a system that limited reward to a fixed value that would be a different matter entirely but I don't.
  6. joe4422


    I think the reason for the reward target is to give yourself an edge, even though we don't know of course where the reward target it. If you're trading the ES, for example, and your risk is three ticks, and your target is 9 ticks, then you only need to win 3 out of 10 times to make money, and 2 out of ten times to slightly lose.

    Those are the desirable odds and the reason for have an arbitrarily bigger reward, even if it means getting stopped out much more often.

    If there is some major major resistance just a few ticks above your entry, then you might avoid that one, because you know that stands between you and your target.

    Something that does work well for target are fibonacci lines. I like to make sure there's enough room between my entry and the next 50% retracement/ pullback.