Why risk:reward ration 2:1?

Discussion in 'Risk Management' started by tinusp, Sep 13, 2007.

  1. tinusp

    tinusp

    I've read a lot of posts giving the advice that your risk:reward ratio should be at least 2:1 but why?

    E.g. with proper money mangement why can I not use a 1:2 risk reward ratio if I'm right often enough?
     
  2. 2:1 is a feel good ratio. It does not guarantee a 2:1 return, regardless of the analysis performed. But your proposal of 1:2 seems somewhat reckless. The age old saying is to let your winners run and cut your losers short. You seem to be doing the opposite.

    All I can really say is, run backtesting scenarios with your 1:2 on a large enough sample size on diff instruments and diff market settings to see what happened. This is much more valuable than depending on forum posts. Even if people give you advice, what worked for them may not work for your trading.
     
  3. empee

    empee

    because even if you have no edge you are more likely to make money.
     
  4. rosy2

    rosy2

    Doesn't it matter what the true odds are. if they're 3:1, why make the 2:1 bet
     
  5. Nobody knows the true r:r, but you have to make trades where you BELIEVE you're risking "x" for the opportunity to make "2x or more".
     
  6. lar

    lar

    R:R ratio is only one part of a whole system. Some need a higher R:R ratio, others can thrive with a much lower R:R ratio. If you make the assumption that your win rate will be random (around 50%) then 2:1 just about breaks even - excepting contest costs and vig - which is why I think that particular ratio is touted.
     
  7. I can't speak for anyone else as I know its an individual matter, but when I started to be more selective with my setups and only played 2 for 1 scenarios, it went a long ways towards bringing me up from bleeding to slightly profitable.

    I swing trade interday with the trend...sometimes I will go for under 2:1... sometimes I will want 3:1 if market conditions (like now) suck.
     
  8. The results of a trading method, system, etc. comes down to two primary factors:

    1) Win %
    2) Winner/Loser Ratio (R)

    If you have a sufficiently high Win % you can have an R of below 1 and do quite well for yourself. It's basically a question of expectancy.

    There is actually a third factor in system performance which is trade frequency. You could have an extremely high expectancy, but in frequent trades, the overall profits might not be worth the effort.
     
  9. As I think about this...

    I guess the "2:1" mindset might apply to those who trade with price targets. That is, they're risking 1.5 points for a stop, and they take profits at 3.0 points.

    Personally, I don't like that approach... "targets" are bogus in my view. There should be a better reason for closing out a winning position other than "I'm ahead ___points".
     
  10. Agree.

    I don't use risk:reward ratios (too much in conflict with the current price action) although I did use them early on in my trading career.

    I prefer to use the current information price is showing after my entry to determine where I actually exit a trade even though I do use a pretermine profit target that's not based upon a fixed number.

    Simply, I may exit a trade prior to my profit target (less profit) or beyond my profit tarfet (more profit) depending upon what the price action reveals after my entry.

    Also, risk:reward ratios are misused in my opinion by most (not all) traders because most traders don't realize that fixed risk:rewards ratios assumes that the price action is the same (same risks and rewards) every trading day or the same from trade to trade.

    The market is not the same each trading day and it is most likely different when a trader gets his/her next trade signal especially when volatility changes (it usually does change).

    Mark
     
    #10     Sep 13, 2007