Most journals post trades. I thought why not start a thread in which thoughts about risk and reward, and other aspects of trading can be written down. All thoughtful comments/posts are welcome. If it is a thought you read somewhere and want to share it, write it and include the source.
Most profitable traders shoot for reward > risk. Most wannabe traders shoot for winning percentage because it's hard on the mind. Keyword: most
IMO risk reward is one of the most misunderstood aspects of trading. Of course we all want to risk 1 to make 2 or above but what if the market don't allow that to happen. Lets say you put on a long and your risk reward 1-3, markets starts to go in your direction, so far so good. All of a sudden your see a big buy come in and the market doesn't go bid, instead it pauses. Then a big seller steps in and the market jumps 2-3 ticks down. At this point in the trade your up say 1, what do you do, A) stay in the trade because your risk reward is 1-3, B) take your profit and let them battle it out, C) Do nothing and say to yourself I'll rather get stopped out then brake my trading rules, or D) take some off the table so the pressure is off then see what happens. My answer is D. The beauty is there's no right or wrong answer but the professional intra day traders i talk to don't pay a lot of attention to risk reward like you think they do. They take what the market gives them. In the above example if the market goes another 2-3 ticks against that bigger buyer he's going to probably cover which will lead to more downside action, why would you want to stick around because some trading book told you you much have a risk reward of 1-3. This is just my opinion. I know theres more than one way to trade.
Thanks for being the first to post. I think it is natural when one starts, to first think in terms of winning percentage. The error could however be in thinking of % of winners in isolation, which I understand is your main point.
There are three ways one can measure wins and losses: in dollar terms, percent terms, and gain and loss factors. If X is the percent risk, and Y the percent gain, and assuming a loss then win sequence, to make a gain one needs this: Y-X> XY (and not zero to the right of the inequality as some people might think). Example: if one loses say 30%, and then wins say 50%, his net is not 20% but only 5%. Now cut both Y and X in half, and let us see what is the new net value. Someone could post the result and tell us if there is something to learn. The XY in there is a curse!
My opinion is that R:R is not an isolated factor; rather it goes hand-in-hand with win rate. Let's say I'm a day trader and I do an "eyeball" study of the 5-min price chart and a pattern stands out: I notice that when price stays above a rising 20-period EMA for more than 90 minutes without coming back to touch it and then finally pulls back to that 20EMA, far more often than not price rises at least N ticks before dropping N ticks below that EMA. I conduct a study of every appearance of this scenario over the past month and discover that 80% of the time price moves at least N ticks off the 20EMA without violating that EMA by N ticks more than 80% of the time. I believe I've found a setup with positive expectancy and decide to trade every appearance of this setup because in my limited study it had a win rate of 80% using a 1:1 R:R ratio. Suppose during my study of this price action phenomenon, I further discover that 50% of the time price rises at least 2N ticks off the 20EMA before falling N ticks below it. It appears there is another positive expectancy method of trading this same setup using a 1:2 R:R. I decide to trade the same setup this way because I'll end up with less trades, therefore less commission cost. If I ask you whether you prefer a risk:reward setup of 1:1 or 1:2, the logical answer to me is "not enough information".
Or one can just not consider r:r at all. If the "setup" has a higher than not probability of being profitable, just take it and let it go as far as it wants to go, which will range from not much to farther than you'd believe. The risk is minimal to non-existent since the trade is exited almost immediately if it doesn't do what it's expected to do. The win rate winds up being at a level that makes "positive expectancy" irrelevant.
Could you share your source of data, and the tools in your test lab? PS: Just that you know, I like your posts. (And I agree with you on the new highs, but for individual stocks which I think is what you were meaning).
Good response! What would one say to those who might change their mind after the trade and do the opposite of what they planned: take a profit immediately if it is profitable, and hold on to the loser if it goes against them?