Risk/Reward...some thoughts...some questions

Discussion in 'Strategy Development' started by ER9, Aug 9, 2005.

  1. ER9


    It seems to me that many traders consider a system/strategy built around risk/reward values based on a single trade.

    Either i am misunderstanding everyone or i have not been exposed to another opinion that suggests a different approach.

    It seems other considerations that may have an impact on profit over time are not being considered.

    I have read countless posts that suggest risk -to- reward values that suggest you make at least twice the reward or higher per trade -vs- the risk to be succesfull.

    Lets say you have a rock solid system/strategy that has an 80% success rate but the success rate is reliant upon a small profit accumulation over several trades.

    For example...if your strategy is successfull 4 out of 5 times and lets say the profit per trade is half a point consistantlly but the risk via stop loss is 1.25 points. Well that means .75 profit per 5 trades. If you have a dozen signals a day that can accumulate to a nice profit over time.

    It seems to me that this is very acceptable odds given the skewed risk/reward values. I am wondering what your opinions are and let me know if i am overlooking something or misunderstanding something important.
  2. You are not mistaken in my view. Depends on the rewards people want psychologically, and what hold times and volatility they can handle.
  3. Successful trading is determined by a combination of favorable risk to reward as well as winning pct.

    If your combination works ... go for it.
  4. A common noobie mistake is to have risk:reward integrated into their trading plans in an ex ante manner... then to strive to achieve that R:R by micromanaging every trade with R:R in the back of their mind...

    A micromanagement of R:R on a trade-by-trade basis is, in my view, only suitable for a scalping strategy, whereby R:R is invariably 1:1 and expectancy is then contingent on a high hit rate and/or large $ risk per trade...

    Experienced non-scalpers regard risk:reward as an ex poste statistic... and simply monitor their evolving historical R:R and associated statistics (such as hit rate, max drawdowns etc) as indicators of the current efficacy, or otherwise, of their trading approach (be it systemized, discretionary, or systemized discretionary)... much the same way that an equity curve is analyzed...
  5. it's a proven strategy. but it's all rhetoric unless you get the fill.
  6. When evaluating a strategy it's expectancy that you want to focus on, and R:R is only one component of that.

    Expectancy is calculated as
    win rate * avg win - loss rate * avg loss

    For example, if you win on 30% of your trades for an average of 5 points and you lose 70% at an average loss of 1.5 points, your expectancy is 0.45 points per trade

    .30 * 5 - .70 * 1.5 = 0.45
  7. MD-R2


    This is the hard part for me. I have trouble getting an 80% success rate with an expected 2/1 reward/risk ratio. I'm new, but I'm barely at 50% just trying to get 1/1. Is 80% 2/1 a realistic expectation somewhere down the line?
  8. If you are an active trader (ie at least 4 or 5 trades a day minimum), I think its nearly impossible to gain an 80% success rate consistently over time. There are just so many variables to every trade and so many things that can go wrong even in a "perfect setup". I probably avg about 80 roundtrip trades a day and the thought of being right 4 out of 5 times seems pretty absurd. Any other active traders agree/disagree?

  9. Is that 80% theoretical or actual results ?
    ... over how many trades ?

    You can't tell if a system is rock solid until you trade it.
  10. Agree... when I go through prolonged spells of 60% winners with 2:1 avgwin/avgloss, I know I 'd better ramp up the size to juice the situation, since this is as good as it gets for me...

    If your historical results are at 50% with 2:1 that is great in my view...

    50% at 2:1 (or equivalent expectancy) sounds like a relatively easy thing to achieve, but to achieve these kinds of numbers consistently and over the long run will, in my view, put you in the top echelon of winning traders i.e. in the top half of the 10% (or whatever the number is) of traders who actually make a profit...
    #10     Aug 10, 2005