Risk Reward in Trading strategies

[DaxTrader]

Hi

I know this subject has been scrutinised on this site many times before, apologies, but here we go anyway.

Reading through threads on this board and advice in many books, the consensus view seems to be that genrally when traders are looking at trading strategies, they automaticaly try to go for 1:3 risk reward (as in 10 tick risk for 30 reward) or at the very least 1:2.

I've tried to trade from that angle for years but the more I trade Risk/reward ratios that are on the face of it unattractive, the more it looks like the 1:3s strategies are overcrowded and are therefore less profitable.

In the last 6 months I have been trading some "unattractive" risk/reward ratios such as 1:1 or less where you have a high strike rate, this seems to work well, even if it is uncomfortable to do.

It makes me wonder whether the 1:12 but 80% losers end of the spectrum is also attractive because of the lack of punters trading at that end of the RR spectrum.

What do you think ?

 

[BBB]

I dont quite get the last statement but....

EUREKA! At last! A trader who has managed to think for himself and realise the light at the end of the tunnel! Well done.

Just because it says so in the books, dont mean its right. Are authors traders? No! They are authors trying to sell books.

You've got to do what works for you. There is no right and wrong in this game, only profit and loss.

 

[Mr. Charts]

BBB has written some of the best words ever on this bb.
The whole business is about thinking for yourself and not assuming what you read is correct. I've read quite a few books and the vast majority of what is said about the non - mental part of trading is gibberish.
By all means test ideas you've read, but always think laterally and for yourself. It's not surprising that the vast majority of wannabees fail -
four reasons
a) they can't do it psychologically
b) they don't trade the plan
c) they believe what they read in books and on web sites without testing thoroughly - and testing it live.
d) they really haven't a clue what they are doing and think it's some sort of easy game to play
Richard

Like BBB implies - it's what actually works in the real world that matters - nothing else

 

[Grey1]

Quote " In the last 6 months or so doing some trading on for example 1:1 or less where you have a high strike rate seems to work well, even if it is uncomfortable to do. "

Actually , you are spot on ..

As a trader one would need either to trade the oscillation and go for higher number of wins and take profit quick ( 1:1 ratio ) or trade the trend and take more losses but the let profit run to achieve the 3:1 ratio

TWO facts:--

1) Market oscillates around 3 times more than it trends

2)The probability of achieving higher reward/risk is less that of the lower reward/risk.

Just one concept for you to think about.. THERE IS NOT SUCH A THING AS TREND .. ALL TRENDS ARE OSCILLATIONS IN DIFFERENT TIME FRAMES...

Regards

 

[darrenf]

Mmm. This is very interesting.

I've been considering how I can acheive a higher win ratio and thus a smoother equity curve.

Until now, I've always shot for the 3:1(+) ratio, with a trailing stop which locks in 1.25:1 profit after movement in my favour of 2.25:1.

However, that means that the trade needs to move 2.25 times my risk in order to lock in 1.25:1 profit.

I've considered taking half profits straight away at 1.25:1 but have previously been put off by the fact that it reduces profits on the trades that do run to 3:1 or more.

I suppose I've always used 3:1 for reasons covered previously. ie that's what the books say. However, the more I think about it, the more it makes sense. I think maybe the best approach is to take 1/2 profits quickly, at maybe 1 to 1.25:1 and let the other half run with a trailing stop.

Has anyone else gone through a similar transition? If so, how did it affect your win:loss ratio and did it result in a smoother equity curve. Also, I would be interested to know if it had a positive/negative/neutral effect on overall profitability.

My personal belief is that trade management of this kind is one of the key drivers to success in trading. Certainly, my own profitability as a trader has been the direct result of employing these tactics in a disciplined manner. However, I am always looking for ways to improve/ tweek my rules and I would be grateful for any feedback on this.

It's interesting on how my own opinions about trading have changed. When I first became interested in trading, I always looked for ways of catching the big moves and could not understand why others would want to go for small, steady profits. Now I understand why. Small, steady profits with the occaisonal larger wins= low drawdowns and smooth equity curve.

Anyway, any comments most welcome.

Darren

 

[marky]

Hi Guys
Glad you started this thread DAX TRADER, i also try going for the 3:1 ratio and find i fail more often than not, i trade the YM and always open with a 10 point stop as my entries are ok, also i want to be out quickly if i got it wrong, i always thought that if i didn't take the 3:1 ratio then my money management skills would be considered to be bad and not considered to be a good trader, i also looked at various time frames to help but failed, if i trade 1:1 ratio i find i can knock in several good trades a day and far more winning trades, but its still annoying when it carries on and hits the 30 plus points, take friday on the YM i had a loosing day because i raised the time frame hoping to be in for the big move that never really happened and with a 3:1 ratio, had i stuck with my small time frame i would of had several good hits of 10 points and made a profitable day, so is the ratio of 1:1 so bad, but a high strike rate,

Best Regards to all
Mark

 

[Dow Dog]

My own method is to go for 1:1 and my strike rate is in excess of 80%. I find that I need a high hit rate to keep myself psychologically intact.

I have developed a " way" of trading which is not covered by any books and which would probably be laughed at by "expert" traders. But it works very well for me provided I trade exactly according to my plan with no deviation.

This is the difficult part and when I do deviate it is frightening to see how quickly that 80% hit rate falls.

Mr Charts is correct to put the pyschological factor as the number one reason for most traders failing. This is the aspect of my trading that I have always had to work hardest at. And it continues....
The urge to jump in with gut feeling after a failed trade never leaves me.

 

[goshort]

I agree with Dow Dog. If you can't take it psycholoigically then you will have to increase your win rate and lower your expectation of reward to risk ratio.

This is a personal issue and can only be developed and understood over time - where your own level is.

Goshort

 

[Dow Dog]

I think it's also a function of capital.

As you win more and increase your capital pot, then you can become braver and adjust your hit rate and reward/risk ratio accordingly.

An increasing capital pot makes you psychologically stronger.

 

[TraderPattern]

You've got to do what works for you.

Good post. This is the bottomline line for ALL aspects of trading.

 

[BBB]

Some excellent observations - all made from first hand experience.

Grey 1- interesting point. A while back I decided there was no such thing as a false breakout. I was just trading it in the wrong time frame!

There were other points made regarding banking the small wins. Here's a story:
When I was a clerk starting my trading voyage on the floor of LIFFE, I was working for a medium sized firm of prop trades. They had employed a junior trader. This trader consistently made between £500-£2000 per day. Rarely did he lose. The owner of that company who traded a very large size indeed would always be moaning at this guy and making snide comments behind his back for not taking enough risk and failed to see how he would ever make any real money. He made a point of making this guy feel small infront of others while he beat his inflated chest. This 'big' trader would most often lose - £10k on a good day, £60k on a bad day. On the odd occasion he would make £50k or so. Once in a blue moon, he would hit a home run of £x00,000. Although he was profitable overall. I'm sure he used to be an excellent trader at one stage in order to beable to trade his size. Soon, he hit a losing streak. He started to lose BIG time. His positions were too big and too numerous to get out of at a time when liquidity started to dry up. His 'recreational' drug use became a habit and his wife left him. The result was he had to end his career at LIFFE. The junior, humble trader however is now very successful after 4 years of slowly banking ticks rather than trying to hit a home run with every trade. Just goes to show.

 

[BBB]

...oh yes, the moral of the story is don't try to beat the market or it will beat you. Take profit while it is there rather than trying to impress others and maybe even yourself.

 

[marky]

Hi Guys, and a great thread after re- reading several times i think the penny has dropped, a little but often, pennies make pounds etc, i appears its not just about money management but psychology is the biggest factor and failure of most traders, myself included, as i said in an earlier post i can knock in 10 pointers several times a day and beat myself up for missing the 30 pointers, i have to say this thread alone has help me out immensely.
Best Regards to all
Mark

 

[waytogo]

Excellent thread guys! As someone who is in the first steps to writing an automated system (have only got as far as getting the buy and sell signals onto the chart) I was recently horrified to find that by trying to 'run' all my trades I would only get an average of 1.5 pts /trade (FTSE futures) and have had to rethink my trade management totally. This means that I now always take some money off the table early on and run the rest on a trailing stop. I will now be investigating whether it will be even better to take all the money off the table early on.

The posters on T2W have many times recently brought up topics which have been an enormous help at the right time! Marvellous!

 

[TheBramble]

For me, it's a lot easier. While I understand the concept of calculating the risk/reward ratio, I'm at a complete loss as to how you calculate the reward in the first place.

Sure, your risk is your initial stop. But reading this thread, each trader - with (potentially) a different trading style, using different indicators and entry/exit criteria - has an apparently firm idea of how to calculate a profit target i.e. the reward.

I look on in awe...

 

[BBB]

Tony - Its up to you. Personally, I dont set targets. Too many times have I seen the trend go on and on and on after meeting my objective. Now I just look at price action. If it looks like trouble then Im out.

However, typical price objectives could be resistance, ( or support if short), os/ob indicator readings if you like indicators, ma crossovers whatever. The question is, where or what will be your indication that the move is over? How do you come up with this price? Try looking at volatility - theres your clue.

 

[TheBramble]

The question is, where or what will be your indication that the move is over? How do you come up with this price? Try looking at volatility - theres your clue.

So you're saying you pretty much set your target depending on the indicators/system you're using (Fib, S/R, channel width etc), to set a nominal target, but that let ACTUAL volatility be your guide as to when to get out?

 

[BBB]

Almost. I dont use any indicators in my trading, apart from occasional use of Bollinger Bands.

Don't worry how I trade, or anyone else trades. Whats right for one person wont be right for the next person. Thats why you've got to find and formulate your own ideas. Not a quick and easy process by any means, but if something is worth having, it wont be will it !

Volatility is my guide of when to get in, and sometimes when to get out. Price is king though.

My advice is to look at a load of charts over a few days. When would YOU have wanted to get out? Why? What would have been your signal to get out? Is this signal consistent?

 

[ChartMan]

Good thread. .... that guy that tried to hit the home runs.... and the Junior. He had the right idea ( the junior).. IF your particular plan is working for you, the home runs will be captured as a matter of course, you don't have to seek them out. AND you get a bigger smile on your face too. :cheesy:

 

[DaxTrader]

Gulp - loads of replies, been away for last 3 days, going to take some re-reading to get the full benefit.

BBB - "I dont quite get the last statement but...." badly put, 1:12 as in risk 10 for 120 but with a strategy that fails 80% of the time.

Grey 1 "ALL TRENDS ARE OSCILLATIONS IN DIFFERENT TIME FRAMES..." is very familiar.

I spend a lot of time looking from daily down to 30 min charts to try and get a feel for what kind of a day we might be in, most of the time it is "scalp or measured move" mode, maybe 3 days a month is trend day where the market goes from one corner of the screen to the other.

BBB - re your LIFFE anecdote, talked to someone recently who has traded the bund for 10 yrs on floor and off, not only does he always risk the same as his target, he also doesn't raise his stop...but it works for him.