Risk Reward Myth

This is a discussion on Risk Reward Myth within the Psychology, Risk & Money Management forums, part of the Methods category; Originally Posted by Shakone I think for psychology reasons you want to have a higher than 50% win rate. If ...

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Old Dec 31, 2010, 4:26pm   #9
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Re: Risk Reward Myth

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Originally Posted by Shakone View Post
I think for psychology reasons you want to have a higher than 50% win rate. If you don't combine that with approximately a 1:1 risk reward or better, you're likely to struggle imho. Sure you can have a 90% win rate, and your losers much bigger than winners. But a 90% win rate is hard to keep up. And if you're off your game, or the markets start behaving unusually...you'll lose a lot. For me at least, risk reward is hugely important.
I would certainly agree that win rate is important.. however mine runs at around 30%. But the point about psychology being important (paramount) is always a good one.
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Old Dec 31, 2010, 4:34pm   #10
 
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Re: Risk Reward Myth

The problem with a lower win rate albeit with a much higher average win size to average loss size, is that you are mathematically certain to have much longer runs of losing trades which is emotionally draining to all but the hardiest.
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Old Dec 31, 2010, 4:38pm   #11
 
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Re: Risk Reward Myth

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Originally Posted by Mr. Charts View Post
The problem with a lower win rate albeit with a much higher average win size to average loss size, is that you are mathematically certain to have much longer runs of losing trades which is emotionally draining to all but the hardiest.
Richard


I know my limitations and bearing up under a long series of losses is one of them.
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Old Dec 31, 2010, 7:18pm   #12
 
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Re: Risk Reward Myth

The OP made some very interesting points worth further investigation. The answers cannot be easy but instead must rest on careful analysis. Some of the issues surrounding R:R and win rate are discussed in this paper, especially issues that regard trend following system. A must read:

http://www.priceactionlab.com/Litera...fitability.pdf
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Old Jan 2, 2011, 8:10pm   #13
 
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Re: Risk Reward Myth

I sit on the 1:1, high win rate side of the fence.

With multiple setup's occuring each day my objective is to finnish each day with a profit or an easily recoverable loss.

There is also the benefit of not worrying about missing rocket trades that would have made up for the last 2-3 losers.

This type of setup works better in choppy conditions as well inmy opinion.
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Old Jan 6, 2011, 4:21pm   #14
 
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Re: Risk Reward Myth

really helpful post, I wish I had read this a few years ago!
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Old Jan 8, 2011, 12:56am   #15
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Re: Risk Reward Myth

Copied from a post of mine on ET:

We look at a price chart and within our timescale of interest, we decide where price may go to as a possible target, and where it may go to as a possible stop, or whether price may not move much at all. We use our experience of interpreting charts, observed S/R levels, market indices, futures, news and conclude the likely future direction and extent of a price move.

Some traders have more trading experience and access to information than others, which can be used to narrow down the uncertainty of price movement. The lack of precise information means that we consider a range of possible outcomes of a trade and we try to manage the uncertainty and risk:reward by thinking in terms of probabilities, of our target being hit before the stop:


Expected_gain = Expected_win x Probabilty_of_win - Expected_loss x Probability_of_loss


We try to choose the entry, target and stop so that the expected gain is positive and that the risk:reward is sufficient:

RR = Expected_win / Expected_loss.


Each trade is unique and won't be repeated, but we take the trade on the understanding that if the trade could be repeated with our choosen entry, target and stop under the same conditions, except for those aspects that are uncertain, then the odds are in our favor the we would gain in the long run for that particular trade.
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Old Jan 8, 2011, 2:14pm   #16
 
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Re: Risk Reward Myth

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Originally Posted by meanreversion View Post
I actually think risk:reward is a load of b0ll0cks myself, as it implies that the market actually cares about what you're doing. Furthermore, it implies that the only strategies which can make money are those with a ratio of 2:1 or 3:1.

You set the risk, the market gives you the reward.

However I think there's a little grain of truth behind the idea of 2 or 3:1, as it clearly implies small losing trades and big winning trades.

One of the main cognitive biases leading to losing money is cutting winners too soon and running losses for far too long. If you were to stick with 2:1, that's not going to happen.

Having said all that, I trade a trend model where I don't have any profit targets.. I've been unable to find a robust mechanical system which uses profit targets, and indeed when I did trade this way, I frequently came across the dilemma whereby (e.g.) the profit target was 100 pips, and the market would get to +97 pips before reversing. Profit targeting doesn't really tell you what to do in these circumstances.
Profit target with a trailing stop
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