Optimal Risk .vs. Reward Ratio on FX trades

This is a discussion on Optimal Risk .vs. Reward Ratio on FX trades within the Forex forums, part of the Markets category; Right guys, I wouldn't normally be placing a post desperately asking for help and advice but here goes : I've ...

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Old Nov 16, 2004, 10:00am   #1
Joined Sep 2004
Optimal Risk .vs. Reward Ratio on FX trades

Right guys, I wouldn't normally be placing a post desperately asking for help and advice but here goes : I've been trading FX for my own account for around 2 years and haven't made or lost a cent. Although I place good trades I can't seem to make any cash. Here's my story, I have this idea in my head that I use very short term 5 min charts to attempt to perfect my entry point on a trade that I have picked up using a combination of hourly and daily charts. Essentially what I'm looking to do is go for the 100-200 pip trades using a very short term entry point. I suppose this makes a bit of sense but the problem is that I'm using tight stops of 10-15 pips which is resulting in me getting stopped out of 85% of all trades (I've done an analysis of my account) Due to limited capital I tend to put a stop at my point of entry as soon as my trades go 10+ pips in the money. 65% of all my trades are stopped out for zero profit .ie. 65% of all my trades go into the money straight away but then the market ticks back and stops me out. I think I may have lost the plot here as I'm essentially risking 10-15 pips in the hope of making 100-200 pips. I would say that most of trades are fairly good and ultimately would have made some decent cash had I not been stopped out. Funnily enough I trade FX for a bank for a living and do extremely well (using fairly wide stops) but can't make a cent trading my own account. I seem to be limited by trading capital and my need to be trading these ridiculous risk.reward setups of 1:10 or 20.
Can someone give me advice? What is the ideal risk.reward profile and what would you suggest as both a min. and max. stop loss trading a USD 10,000 account? I have heard 1:2 or 3 and stop losses between 20 (min) and 50 pips (max)
When I read market reports and all that jazz, most of the banks seem to set these huge stops of around 100+ pips which would be helluva nice but not particularly realistic with my a/c size.
What do you guys think? Any help would be appreciated.
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Old Nov 16, 2004, 10:29am   #2
 
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Quote:
Originally Posted by roguetrader100
I would say that most of trades are fairly good and ultimately would have made some decent cash had I not been stopped out. .
Surely you have answered your own question - your stops are too close. If the natural volatility of the market is greater than your stop - which it seems is the case here, then risk reward profiles are unimportant, aren't they? Surely risk V reward can only mean anything when probability of direction is factored in. If your stop is within the natural range of the price, you will lose.

I would suggest that your stop isn't dictated by your account size, but by where the chart says it should be. the effect of this risk on your account shoulr then be used to question whether to place the trade or not.

All IMHO.

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Old Nov 16, 2004, 10:46am   #3
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If you have an exit strategy backtest say 100 trades using no stoploss.

List the results in a spreadsheet with the maximum adverse market movement, you can then do a data sort on this and find the optimum stoploss.
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Old Nov 16, 2004, 10:56am   #4
Joined Sep 2004
roguetrader100 started this thread Yip guys, here's a question. How far away from support/resistance levels would you place a stop loss ito pips? I always place my trades off support/resistance levels with a stop on either side. The market has been pretty whippy of late with a lot of false breakouts (in terms of short term trading) As an example, I got stopped at 1.3005 on EUR/USD on Fri. This happens a lot. Should I have them further of these S/R levels?
Thanks for the replies so far. Appreciated.
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Old Nov 16, 2004, 11:57am   #5
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roguetrader100 started this thread Essentially what I do here in SA is trade the FX portfolios of large corporate clients. It's effectively the only way to speculate on the ZAR due to exchange control regulations here. Only designated market making banks (and there are only a handful) are allowed to make a market in the ZAR. Otherwise, it is only possible to buy and sell FX in this country if you have an underlying committment in the form of an import or export order. Essentially, we combine all these orders and then spec on the ZAR in between. Keep in mind that the ZAR trades on a huge 500 pip spread and I've done really well. Of course I have a huge balance sheet behind me. Just getting bloody frustrated trading my own a/c and seem to be in a bad way mentally - far too risk averse ito my money management.
Yip, it seems that I'm going to have to get down to some hard graft backtesting my strategy and try to see where I'm going wrong. Thanks.
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Old Nov 16, 2004, 12:16pm   #6
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roguetrader100 started this thread Those dirty buggars are cleaning it up down here. They quote the ZAR on a 5 cent spread (500 pips) to corporates dealing R 10 Mln plus per annum. The smaller guys get taken for about 25 cents on the USD/ZAR. It's criminal but the volatility is huge and good if you get it right. There's around USD 4 Bln going through the local banks on the ZAR per day (the rest is offshore) so you can imagine that it's a great currency to be a market maker on. Do the maths and they're having happy days on the spread.

Yip, I think you've struck the nail on the head. I certainly know what my problem is but am looking for confirmation from a few other traders. Not something I would usually do but I feel mentally frozen at the moment and unable to think logically on my own a/c. I know what the prob is but have been unable to break out of my habit of cutting my losses and potential losses to quickly. I rate I'm in a bit of a 'capital saving' as opposed to 'capital appreciation' mentality, trying not to lose as opposed to actually making cash.

Keep well all and nice chatting. Thanks.
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Old Nov 16, 2004, 1:31pm   #7
Joined Jun 2003
Hi RT

A very interesting post as this is how I trade GBP everyday.Using the 60 min for direction and trading off S&R area's using a 5 min chart to time the entries.

Personally I go in on 4/5 'lots' and scale out at S&R levels off the 60 min.

ie. Enter with 4-5....Scale out 2-1-1-1 and very,very rarely do I move my stop to B.E. when it moves 10 pips in my favour as it is just to close in my opinion.

Instead I 'hedge' my initial risk by exiting two positions at the next appropriate S&R level/ or 'first target' area.This usually means my remaining 2/3 lots are at a no/very limited risk level because if my timing was right off the 5min TF, my entry level stop is likely to be within 10/ 20pips (incl spread) and the '2' I scale out at first target should balance off my initial exposure in the trade....then its just a case of letting them run

Obviously it is much easier to do this when you have several positions open as it allows you a great deal more flexibility in managing the trade on a 'bank and trail' policy.

HTH somehow...

H
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Old Nov 16, 2004, 2:01pm   #8
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roguetrader100 started this thread Thanks for the message. Now we're talking from the same page. Look there's no doubt that it's a great strategy as I basically use it in my current job and it works well. The diff is trading your own cash and to be honest I'm perhaps a little out of touch with where my stops and my exits should be in the major currencies.

Could I ask you a question : Using your strategy of using setups on hourly charts and then using 5 mins to time your entry, roughly how many pips away would you place your stops, and what sort of profits are you looking for on your trades placed off an hourly chart?

This would be very helpful. I have been going through a number of hourly charts on the EUR/USD looking at the setups that I'm keen on and the ave profit on these is around 50-100 pips. Does that sound about right to you? Obviously if the market kicks off you can run it further by holding onto 1 or 2 remaining positions.

What would you be prepared to risk in order to make 100 pips?

Appreciate the help and advice.
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Old Nov 16, 2004, 2:36pm   #9
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Quote:
Originally Posted by roguetrader100
Thanks for the message. Now we're talking from the same page. Look there's no doubt that it's a great strategy as I basically use it in my current job and it works well. The diff is trading your own cash and to be honest I'm perhaps a little out of touch with where my stops and my exits should be in the major currencies.

Could I ask you a question : Using your strategy of using setups on hourly charts and then using 5 mins to time your entry, roughly how many pips away would you place your stops, and what sort of profits are you looking for on your trades placed off an hourly chart?

This would be very helpful. I have been going through a number of hourly charts on the EUR/USD looking at the setups that I'm keen on and the ave profit on these is around 50-100 pips. Does that sound about right to you? Obviously if the market kicks off you can run it further by holding onto 1 or 2 remaining positions.

What would you be prepared to risk in order to make 100 pips?

Appreciate the help and advice.

Agree with you completely RT -trading YOUR own cash is bound to be different and perhaps there is a psychological difference to overcome...I have only ever traded my own cash so I know no other way - I guess the issue for you maybe detachment from the trade...?

Personally my stops are never more than 20 pips away from my entry point and using a 5 min chart for entry they should be in the 10-20 range max...if the entry level stop is more than this its a NO TRADE for me.

I do not guess the entry stops and the levels will be chart based...

I rarely trade swings on the Euro , mainly Cable as it is where I have focused my intraday activity and have got to know its patterns reasonably well...(Have only really done 1 swinger on the Euro in recent weeks so I am not in the best position to answer this one)

If you look at your 60 min Cable charts you will see we are in a fairly large Sym. Triangle.(imho)

***Last night I entered long off the support area at 8459 on the 20:40 candle on the 5 min chart - we had bounced off the uptrend support line and were making higher lows.My entry level stop loss was 8443 (1 pip below the low of the 20:00 candle which I was using as my reference).

My target areas for scaleout have been 8502 (2 out) 8530 (1 out) 8541 (1 out) and still holding 1 lot (although its getting messy up here now).

So the initial risk was min. compared to the potential rewards and as soon as first target had been met 2 lots were closed on a limit order and the trade was '0' risk from thereon in.

Looking for these sort of set ups are ideal as you have clear areas highlighted for exit and this trade has now delivered 239 pips today with 1 still open ...although looking at this 1:30 spike it may not be for much longer .lol.

** can be verified by several members on this site - just in case anyone thinks I am cherry picking !

Hope this answers some of your questions.I am still a newbie myself RT so there are others in here who may be able to offer other ideas.


Best Regards
H
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Old Nov 16, 2004, 3:01pm   #10
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Quote:
roguetrader100 -
I've been trading FX for my own account for around 2 years and haven't made or lost a cent. Although I place good trades I can't seem to make any cash.
Hi roguetrader100 - I suppose things could be worse - you havent actually lost any money!

This quotation should act as a stark warning to anyone who is contemplating quitting the day job and moving into full-time intra-day trading.

If you look at any fx chart - it seems that as a trader you cannot fail to make money - by staying on the right side of the big trends. However, if you find that you have a habbit of say going long and then seeing the market reverse - hitting your stop-loss - meaning a 10-15 pip loss per time - it is easy to see how it is possible to struggle to break even.

A robust and well considered and back-tested trading strategy with entries that present a higher probability of success - should go a long way to fixing this problem.


Cheers

jtrader.
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Old Nov 16, 2004, 4:09pm   #11
 
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If you want to use 10-15 pt stops then buy on retracements not on breakouts.

If you do want to continue to trade breakouts consider a reentry strategy,
if you get stopped out re-enter when the market goes back to your original entry price.
This is not something i do myself but some traders claim to use this approach with success..

Last edited by donaldduke; Nov 16, 2004 at 5:41pm.
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Old Nov 17, 2004, 12:44am   #12
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Quote:
Originally Posted by roguetrader100
Funnily enough I trade FX for a bank for a living and do extremely well (using fairly wide stops) but can't make a cent trading my own account. I seem to be limited by trading capital and my need to be trading these ridiculous risk.reward setups of 1:10 or 20.
If the r/r ratio is 1:10, the possibility of occurrence of a winning trading will be very small. Otherwise, anybody can to get rich very quickly.

I don't want to write more since you have given out almost all the answers to your own doubt. MetaTrader can be used to backtest and it is free. But backtesting doesn't always reflect reality. Good luck.

Last edited by Hayek; Nov 17, 2004 at 1:02am.
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Old Nov 17, 2004, 6:55am   #13
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roguetrader100 started this thread Guys, thanks for all the replies. It is very much appreciated. Cheers and all the best.
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Old Nov 17, 2004, 6:12pm   #14
 
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FXCM at their open day 'cucumber sandwich' lectures, lean heavily on advising 30 point stops and r-r of 1:2.

(Just on the offchance you want to take trading advice from a market maker... )
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Old Nov 20, 2004, 8:45pm   #15
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Joined Jun 2004
Quote:
Originally Posted by roguetrader100
Right guys, I wouldn't normally be placing a post desperately asking for help and advice but here goes : I've been trading FX for my own account for around 2 years and haven't made or lost a cent. Although I place good trades I can't seem to make any cash. Here's my story, I have this idea in my head that I use very short term 5 min charts to attempt to perfect my entry point on a trade that I have picked up using a combination of hourly and daily charts. Essentially what I'm looking to do is go for the 100-200 pip trades using a very short term entry point. I suppose this makes a bit of sense but the problem is that I'm using tight stops of 10-15 pips which is resulting in me getting stopped out of 85% of all trades (I've done an analysis of my account) Due to limited capital I tend to put a stop at my point of entry as soon as my trades go 10+ pips in the money. 65% of all my trades are stopped out for zero profit .ie. 65% of all my trades go into the money straight away but then the market ticks back and stops me out. I think I may have lost the plot here as I'm essentially risking 10-15 pips in the hope of making 100-200 pips. I would say that most of trades are fairly good and ultimately would have made some decent cash had I not been stopped out. Funnily enough I trade FX for a bank for a living and do extremely well (using fairly wide stops) but can't make a cent trading my own account. I seem to be limited by trading capital and my need to be trading these ridiculous risk.reward setups of 1:10 or 20.
Can someone give me advice? What is the ideal risk.reward profile and what would you suggest as both a min. and max. stop loss trading a USD 10,000 account? I have heard 1:2 or 3 and stop losses between 20 (min) and 50 pips (max)
When I read market reports and all that jazz, most of the banks seem to set these huge stops of around 100+ pips which would be helluva nice but not particularly realistic with my a/c size.
What do you guys think? Any help would be appreciated.
Rogue, your question relates directly to expectancy. Understanding expectancy is essential to profitable trading. From the figures you quote you actually have a positive expectancy in fact you should be very profitable. Here's why:

Given the following assumptions from your information: 65% you make nothing, 20% you lose 15pips, 15% you make a risk : reward of 1:10 i.e. 150pips, then your expectancy is (0.65 x 0pips) + (0.2 x -15pips) + (0.15 x +22.5pips) = (0) + (-3) + (22.5) = 19.5 pips. Therefore you should, on average, make 19.5 pips per trade.

I'm not trying to be a smart ars* but thinking in this way when analysing your trading can help answer many trading questions. Combine this with good money management which will allow you to make a string of losses without wiping out your account (but still maintaining a long term positive expectancy) and you are on the road to coming out ahead. The entry & exit method and time frame used are of course a matter of personal taste / trading style.

BTW Nick Leeson never practised good money management and we all know what happended to him
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