Risk/reward in the Long Run ...

[maildigger 10]

A) What kind of risk/reward are you looking for in combination with the % winners/losers?

 

B) Assume you have a small edge (55% winners, 45% losers) as a trader. What kind of risk/reward would you consider as enough in the long run ( 1:1 / 1:1.5 / 1:2 / 1:2.5)?

Edited April 1, 2008 by maildigger

[james_gsx 16]

I would want at least 1:1.5 (risk $1 to make $1.50) if your odds are like that. Obviously, the more the better. This way, if you take a series of losers after a series of winners you won't be back at break even.

[trader273 10]

I think that there needs to be a "Realism" factor in this ratio. Anyone can say they want to risk 1 to make 10, but how realistic is that you are going to make ten before losing 1? If you can consistently stay about 1, and depending on your trading costs, you can go around 50% and break-even. Being more realistic, you would probably have to go around 55-60%.

 

Then the question becomes how do you quantify this throughout the day. Do you keep a constant 1:1.5 ratio? So either you have a fixed profit in mind and your stop will be based on that, or your profit objective will be based of your stop. Either way, you will be hard pressed to remain consistent. What I mean is, some trades will require smaller stops which means smaller profit objectives ( if you are staying at a constant 1:1.5). Now a problem will arise if you take your profitable trades on the smaller profit objectives, but take your losses on the larger stop/profit objective trades.

 

Some trades might say, well no matter what I'll have a 2 point stop and a 4 point target. This might work for some, but without using market structure to figure profit objectives and stops, I believe you will find yourself frustrated with the amount of stop outs.

 

I am not suggesting that money and risk management isn't key in successful day trading, I just do not believe the risk-reward ratio is as important as everyone makes it out to be. It looks good on paper, but in practice it can be hard to maintain.

[smwinc 20]

A) What kind of risk/reward are you looking for in combination with the % winners/losers?

 

B) Assume you have a small edge (55% winners, 45% losers) as a trader. What kind of risk/reward would you consider as enough in the long run ( 1:1 / 1:1.5 / 1:2 / 1:2.5)?

 

 

Risk to Reward is a stat you evaluate in hindsight.

 

You can ESTIMATE your reward, and (generally) fix your risk. In my opinion, risk/reward is completely over emphasised. It is an assumption. The trader who thinks he can fix his risk has never had a stock gap, undergo a trading-hold, your broker/platform/exchange/internet go down, etc.

 

Similar story for win/loss %. Who cares, seriously? Today I had 7 losers in a row, scratching / -1 tick trades. Then I hit a winner, got onto a runner, scaled in aggressively and made a little over +40 ticks.

 

Win to loss at that point in time = 10% winners / 90% losers.

 

The important stats are things like:

 

-Average winner vs average loser

-largest winner vs largest loser

-distribution of winners/losers above your average (i.e. averages can be misleading, especially if you have a small sample)

- Max/average adverse excursion & max/average favorable excursion

 

Am I on my own in thinking this? perhaps worthy of a discussion.

[torero 10]

I agree r/r is only an assumption that you will get that, but in reality it rarely happens as expected. Even when you try to keep as such, you become boxed in by that very concept you do reach your reward target, not letting profits run becomes a crutch down the road. For me, the best judge of good strategy is avg win/avg loss in combo with #losses/#wins. If you find out your # wins to losses you have an idea how to work on picking better setups with smaller stop losses but not the target as it's more unpredictable.

[maildigger 10]

If you don't care about risk:reward ... Scaling out is essential? Or how do you determine where to get out?

[trader273 10]

If you don't care about risk:reward ... Scaling out is essential? Or how do you determine where to get out?

 

If you scale out of winners, you better be scaling out of losers also.

[DbPhoenix 42]

If you don't care about risk:reward ... Scaling out is essential? Or how do you determine where to get out?

 

Judging by your posts here and elsewhere, you appear to be fairly new, and much of what you want to know may become clear as you become more experienced (I'd like to say "will" become clear, but that is often not the case). Issues of nearby rewards and tight stops and trailing stops and risk:reward ratios and where do I enter/exit and how I do I distinguish up from down are among the most common puzzlements that beset beginners and are all a consequence of their not knowing just what it is that they're looking at.

 

Once you understand what you're looking at and become familiar with it, you should be able to determine the best entry for your risk tolerance, and you will have defined what constitutes a reversal signal (I say "should" because many people never do). Once that's accomplished, it's simply (but not necessarily easily) a matter of entering when you're supposed to and staying in until you get your reversal signal. At that point, all the issues regarding stops and r:r and cutting profits short and so forth will for the most part evaporate.

[smwinc 20]

If you don't care about risk:reward ... Scaling out is essential? Or how do you determine where to get out?

 

Perhaps I wasn't clear.

 

The example of scaling in was just an example to illustrate you can have many losing trades, and then one winning trade to finish in profit.

 

Often it is much better to "work hard" to get a good entry price, rather than take a trade, and wait.

 

The entire concept of risk to reward assumes you know your risk AND reward to begin with.

 

What I get tired of is day-traders (not so applicable to position traders) choosing trades that fit their minimum risk:reward.

 

Worse is when traders go "OK I can only risk $1,000 / x number of points, so that means my stop is going to be here".

 

I don't like predicting. Guru's and people who can't make money trading, predict and sell software, seminars, etc. Traders trade. It's fine to have scenarios, but it's unwise to make a trading decision before the trade starts.

 

E.g.

 

1. "market is at 1200. I think we will go to 1250 for XYZ reason."

2. "stop is going to at 1190 for ABC reason and target at 1250.

3.risk:reward = 1:5 = meets my trading plan rules, great!"

4. "money management rules I created state I can risk $1,000 a trade which means I'm putting on XX number of contracts"

 

In reality the above 5 sentences are:

1. -Assumption & another Assumption.

2. -Decision based on an Assumption, another Decision based on an Assumption.

3. - Congratulating yourself based on your ability to make Assumptions

4. - Adding another nail in your coffin by making another Decision based on another Assumption. More Congratulations in order.

 

Do you see the problem here? nothing has happened in the market yet.

 

Better trader:

 

1. "market is at 1200. I think we MIGHT go to 1250 for XYZ reason."

2. "enter the market. mental stop on price action/fixed stop I always use. No target because I don't know what the market will do, ever."

3. "money management rules indicate I enter all trades with the same size, and add if the (rare) opportunity arises when the MARKET confirms the situation. I will be aggressive and quick to get out the second I am wrong (can always get back in), and will not let the additional size negatively impact the performance of the trade."

 

It really is just a few core differences, limiting decisions based on assumptions, or decisions before an event has occurred.

 

Don't get me wrong, it's not a clear cut issue. A common bad trade is where you go against the major trend of the day for 1-2 tick trade. The trade goes against you slightly, you average in (only ever hoping for 1-2 ticks), and you end up taking a 10 tick loss. That's a good example of keeping your reward in perspective. If for whatever reason, you DO have a Fixed Target, then (for better or worse) you need to trade that way.

 

Everyone makes money differently. Plenty of people fade moves to average in and take a small profit on a large size. I call it a Rubber Band Reward Curve. If you graphed their "reward curve" it's actually increasing as the market moves away from their entry (because their adding into their position) before it hits zero when you have reached your position limit and the market is still not going your way - hence the 'rubber band curve' - and your trade 'snaps'. Personally, I think that suicide. I prefer to dip my toe in the water, and unleash when the trade is going in my favor.

[smwinc 20]

At that point, all the issues regarding stops and r:r and cutting profits short and so forth will for the most part evaporate.

 

You sir, deserve a medal.

 

Amen to that post!

[torero 10]

I usually treat scaling in and out as each separate trades so keep things simple. If I get in at $10 with 900 shares, then scale out 300 (trade 1) at $11, then another 300 at $12 (trade 2), and so on.

Edited April 2, 2008 by torero

[trader273 10]

I usually treat scaling in and out as each separate trades so keep things simple. If I get in at $10 with 900 shares, then scale out 300 (trade 1) at $11, then another 300 at $12 (trade 2), and so on.

 

Well if something like that works for you that is great. However, whenever I have run a test of piecing out vs all out, the scaling out has never come out ahead. It always seemed that I would take less on the winners ( since scaling out lowers your average when compared to getting all out). Like your example here. Your average profit is 1.5 instead of 2 if you got all out at 12. But when stops occurred, it was for my full lot. Just doesnt make sense to me that I would be willing to take a full loss on my full lot, all the while taking less on my winners. Maybe it was just me though. Every trader has their own way.

[torero 10]

I usually scale in as the market goes my own, sometimes more positions as the trend is confirmed. But I only say this for forex because I have found the e-minis to be less trendy so pyramiding doesn't do as well.

[neutral 10]

:helloooo:

 

i strongly advice all newbes to stop, to read, to contemplate and to understand this post

 

Judging by your posts here and elsewhere, you appear to be fairly new, and much of what you want to know may become clear as you become more experienced (I'd like to say "will" become clear, but that is often not the case). Issues of nearby rewards and tight stops and trailing stops and risk:reward ratios and where do I enter/exit and how I do I distinguish up from down are among the most common puzzlements that beset beginners and are all a consequence of their not knowing just what it is that they're looking at.

 

Once you understand what you're looking at and become familiar with it, you should be able to determine the best entry for your risk tolerance, and you will have defined what constitutes a reversal signal (I say "should" because many people never do). Once that's accomplished, it's simply (but not necessarily easily) a matter of entering when you're supposed to and staying in until you get your reversal signal. At that point, all the issues regarding stops and r:r and cutting profits short and so forth will for the most part evaporate.

[darthtrader 10]

Just doesnt make sense to me that I would be willing to take a full loss on my full lot, all the while taking less on my winners. Maybe it was just me though. Every trader has their own way.

 

I pretty much agree totally with what smwinc posted. The problem with scaling out is you need to have an extremely high win rate that is extremely consistent. If your putting on full risk on losers and scaling out then you will never have full risk on for your big wins, but will have it on for losers. To me the long term problem with that is your never going to be able to figure out when a massive buy/sell program comes in and sweeps the market, or a random news event moves the market. You will be on the wrong side of that event with full risk on and not ever get lucky and have full risk on while being on the correct side of that event.

[torero 10]

If you're talking about scaling out, then yes, there are disadvantages but for some, the need for instant gratification is still uncontrollable so by taking off a 1/4, 1/3, etc. to make him feel better and let the rest run. At least he's more of less breaking even if the rest don't pan out. Sometimes, meeting a resistance/support zone with full position can be somewhat risky if prices reverses and runs away. Just saying, taking some profits and let the rest ride wouldn't be a bad option is all. I do it but I do it scaling in a well. I'm speaking of scaling in when the market goes my way, not averaging down.

 

I think the problem with new traders is that they tend to take profits too fast , usually the entire position and miss out on the rest of the trend. I think this is a best progressive way to encourage them to stay in a position longer when the trend is going their way and learn from "holding when you're right". I, for one, get more aggressive when the market tells me I'm right, I'll pile in.

[Northern boy 10]

simply put i think trailing stops is the wiser substitute for scaling out.

 

a r:r of 1:3 in a random market will obviously succeed. the market's not random but it's not against you either (so long as you're not a crowd :p). Scaling out is kind of like creating a new position in a new circumstance you're now uncertain of.

 

but yeah, as it was said, scaling out can only neutralize your r:r ratio imo. just trail it.

Edited May 22, 2008 by Northern boy
error

[Northern boy 10]

Perhaps I wasn't clear.

 

 

 

 

2. "enter the market. mental stop on price action/fixed stop I always use. No target because I don't know what the market will do, ever."

 

 

 

actually that's better put.

[Paul71 10]

Judging by your posts here and elsewhere, you appear to be fairly new, and much of what you want to know may become clear as you become more experienced (I'd like to say "will" become clear, but that is often not the case). Issues of nearby rewards and tight stops and trailing stops and risk:reward ratios and where do I enter/exit and how I do I distinguish up from down are among the most common puzzlements that beset beginners and are all a consequence of their not knowing just what it is that they're looking at.

 

Once you understand what you're looking at and become familiar with it, you should be able to determine the best entry for your risk tolerance, and you will have defined what constitutes a reversal signal (I say "should" because many people never do). Once that's accomplished, it's simply (but not necessarily easily) a matter of entering when you're supposed to and staying in until you get your reversal signal. At that point, all the issues regarding stops and r:r and cutting profits short and so forth will for the most part evaporate.

 

 

Hi DB.

 

Good post, and may i say, i'm enjoying reading your 'work' again.

 

I suppose true risk lies within a traders own understanding of supply and demand, greed and fear, market psychology, strength and weakness, price action, support and resistance.

 

People/traders often argue about 'the numbers', different ratios and so on, but this is only in context/reference to thier own ability, and to a certain degree, has no real relavence or bearing to anybody else, or dare i say, even the market.

 

 

Good to read you again, DB.

[DbPhoenix 42]

 

People/traders often argue about 'the numbers', different ratios and so on, but this is only in context/reference to thier own ability, and to a certain degree, has no real relavence or bearing to anybody else, or dare i say, even the market.

 

Or even to the trader. The trader really has no idea what the risk/reward "ratio" is, only what he hopes it will be. And I suspect that many traders stay in losing trades because of the reward that they are sure they are going to receive.

 

I suggest, therefore, that beginners focus on the risk, then stay in as long as the market allows them to.

[BlowFish 10]

Im surprised no one has directly mentioned position size. If you enter at X and determine Y is a good place for your 'technical' stop based on market structure (for example above the last swing high) you are now in good shape to determine your position size based on how much you want to put at risk.

 

The key metric (imho) is risk of ruin. My favourite site that talks about that is http://www.traderscalm.com/ Im not affiliated just thingk its a great little site and free to boot.