Why favorable R:R?

Discussion in 'Risk Management' started by frostengine, Dec 8, 2008.

  1. It seems anytime money management is brought up, your told for example to make 2 pts for every 1 you risk... or 2.5:1...

    The reasoning is normally something along the lines of if your doing 3:1 then you only have to be right x% of the time to be profitable... Which is beneficial because you don't have to "predict" which way the market will go....

    It seems like common sense that if you have a 50-50 shot of the market going up or down, then simply cutting your losses quick and letting profits run will result in you being profitable..

    All the testing I've done shows this to be incorrect. Whether your Reward/risk is 3:1 or 1:3 does not matter because your chance of it being a winning moves WITH the risk/reward ratio...

    The win% is actually very efficient at moving correctly with the changes in the risk/reward ratio. Which means for it to be profitable you do infact have to have a edge giving you a better than 50-50. Chance.

    This is not a debate about expectancy. Yes you can have a profitable strategy that only wins 30% of the time but makes money due to the winners being substantially bigger than losers... The point i'm making is that strategy at its core has to be better than 50-50 since the win% will move in line with the risk/reward ratio...

    Hence, their is no obvious reason I see to strive for a ratio such as 3:1...so how come vendors, books, traders all harp on needing to have bigger winners than losers?

    *NOTE*: Granted I have seen cases where moving the risk/reward ratio made an unprofitable strategy profitable.. but after further inspection this appears to just be random chance where the numbers happen to "fit" good there.. the same thing can be accomplished by bringing the risk/reward ratio towards more risk and less reward as well...

    Has anyone else backtested sufficiently large quantities of data and come to the same conclusions? Or am I seeing things that is not there?
  2. empee


    my opinion is the better the risk reward required/wanted means less of and edge and/or offset randomness.
  3. Most profitable traders I've watched trade in person (retail, prop and institutional) do not use fix risk:reward ratios.

    I'm also saying that I've watch a few profitable traders use fix risk:reward but they are the minority.

    Simply, there are other ways of managing your risk:reward without the typical fixed scenario we commonly seen thrown around at discussion forums.

  4. If you use a robotic risk and reward ratio than you are not adapting or even trying to adapt to the current market.

    Being a successful trader means adapting to the market.

    If there are no swings during the day than don't expect to trade swings.

    If there are no trends or if it is flat than don't look for trends.

    If there are no key support and resistance lines that can be traded than don't look for those trades.

    Of course you need different R:R for different strategies but that is not the statement I am making.

    What I am saying is that you could be using the absolute same strategy but the R:R could be changing day in and day out.

    The basic factors and characteristics that are involved in the changing of R:R is volatility, time and frequency.

    The bottom line is that you need to adapt and it could be the difference between breaking even and making profit.
  5. Completely Agree!

  6. Cutten


    I look for trades that are 90% likely to work, and have 5:1 payoffs or better. They are rare but usually at least 3 or 4 per year, and that's where I make most of my profit in position trading. Really those are the ONLY trades I should take long-term, but I'm not yet selective enough.
  7. mynd66


    Assuming that your strategy doesn't incorporate fundamentals, I was wondering that since the markets are fractal (or maybe some don't think so), couldn't you take a long term strategy and apply it to a shorter time frame with the same R:R?
  8. You address a very important question in trading. You are however making mistakes from the start. For instance the winning prob does not depend on the ratio risk/reward, it depends on the value of risk! Also the 50-50 chance you quote at the beginning is wrong. It is much less than that. Rethink it.

    I suggest that you rewrite your post in light of these comments, and we will have a look at it again.

    You are on the right track though. I have covered the topic of your thread on some posts here, and also on RFT's financialtraders blog, and I have been stressing the importance of truly understanding the nature of the question you are posing to yourself. There are technique to increase your risk/reward ratio. But first of all, you need to rewrite what wrote first.
  9. Expectancy is much more important than pure R to R.
  10. 1. Define "frequency"

    2. There are other factors (for instance approaches to manage entry, exit, and also profits soon after entry).
    #10     Dec 9, 2008