Risk Reward Myth

Pat494

Legendary member
13,565 1,344
Final bump!

A big fan of Cheese and Fudgestain. No knowledge of Blotto/Hoodoo Man.

Could anyone enlighten me as to what Fudgestains off-site activities were? Same with Hoodo, really.

PM if better.

Thanks in advance.
Can't say I have ever heard of them. So why not post some of their gems of wisdom ?
 

DionysusToast

Legendary member
5,963 1,498
Hi all,

I just thought I'd raise this (maybe controversial) point. All new traders are taught have your winners bigger than your losers. Thats fine, im not saying this is wrong, but I feel the logic is flawed.

The argument supporting this is you are rewarded twice as much for every time you are right (in a 1:2 risk reward example). However this implies your odds of having a winning trade are 50/50. They are not.

Assuming no slippage and commission (an ideal world) and you have a 1:1 risk reward profile the odds of you winning are 50%. You can flip a coin randomly in the market and you would win 50% of the time. After a couple of hundred trades flipping a coin you would be break even on ticks (again assuming no trading costs).

HOWEVER, if you risk 1 to make 2 the odds are not 50/50 because you are expecting the market to move twice as far in your favour to make a profit. To use the coin example again, 1:1 risk reward is a 0.5% chance of winning. However a 1:2 risk reward the odds of you winning are 0.5 x 0.5 = 0.25% chance of winning.

So again if we were to trade randomly following a strict risk reward of 1:2 (with no slippage and commissions) and you entered long on heads with a target of 12 ticks and a stop of 6 ticks (and vice versa) after a couple of hundred "spins" you would have won about 25% of the time and be about flat on ticks.

So, lessons I feel can be learned, if you are a new trader provided you stick with exactly the same risk reward profile on every trade (so the probabilities balance out) you do not have to have winners bigger than your losers. You will not make anymore money but I feel it is easier to stick to a plan that results in a winner every other trade than one that results in a winner every third trade. It will help confidence.

Also, this does not teach you how to have an "edge" in the market, thats up to you, but with a consistent risk:reward profile and consistent position sizing even random trading can keep you from quick blow outs.

Of course we have trading costs, so a 1:1 risk reward in theory is 50%, but after costs its more like 45% expectancy. Hence this is a negative sum game. However, if after years of studying the markets you can improve on randomness by 6% (not sure how this is expressed in mathematical terms) you now have a positive expectancy and are a profitable trader!

Please feel free to correct me if I am wrong, just highlighting its about expectancy not risk:reward which is where most people start (and stop) their learning. The greater your risk: reward ratio the lower your win rates will be. Why harp on about the risk 1 to make 3 all the time?
I know a market maker whose stats are:

85% wins
10% scratch
5% losses

Much of the time he's in the market for less than 10 seconds. The majority of the time he's looking for a tick.

A trade against is quite often more than his 1 tick target.

So yes - there is no law that says risk less than your target.
 

Nuadarne

Newbie
9 0
Thanks for bringing up this crucial topic. Yes, myth is the right word to use. From the very beginning a lot of traders get wrong understanding of the trading strategy, they are less carefully but more enthusiastic, they believe that trading is all about rewards and the more you give the more you get.
 

J_C_Anderson

Active member
116 17
For sure, risk rewrard ratio is extremely important. If your strategy has poor risk reward ratio, it can cause losses even if the win rate would be perfect. To check the risk reward ratio of your strategies you can use special tools for backtesting like Forex Tester. It will provide you with the results of possible performance of the strategy in long term perspective.

Optimal RR for daytrading is at least 1/2 - 1/3, for swing trades - 1/5 to 1/10, but, again, it all depends on your strategy.
 

FXX

Experienced member
1,140 195
Risk reward is a myth. You cannot know how much the market will give you so how can you possibly define a ratio beforehand. The end result is an account that is chewed away gradually as the ratio is not met on a sizeable portion of trades.

Don't apply risk reward, you are wasting your time and inflicting a false sense of security
 

Akinozragore

Junior member
32 2
Actually, it is not always expected to establish take profit a few times higher than stop-loss. Everything depends on the trade system. I saw repeatedly the reports with the results of trades from professional traders (generally that were assets managers), which clearly showed that they trade with a small take, but big stop. And in a longterm perspective trader was in the black. Believe or not in this report - is another question, but following this logic you can doubt the efficiency of any system. The classic system teaches us to make big take and small stop (for example, in the ratio 3:1). Maybe it is considered if you already could determine the right move, you need to take maximum out of it. And if you made a mistake, it is better to leave the market as soon as possible. I think it is a quite primitive tactic. It is like to trade with MA and RSI by the default settings and expect to be in black on the distance :)
 

JohnnyForex

Member
50 1
TheBramble said:
You may want to augment your provenance with this site by mentioning the nature of Fudgestain’s off-site activities and why when Mr. Marcus blew the whistle on him he disappeared forever.


Bumping an old thread as I was reading older posts.

It looks like TheBramble is no longer active, but I was wondering if anyone had any more information on Fudgestain or Hoodoo Man (Blotto on ET?)?

The reason I'm asking is that I'm a big fan of the posts by Cheese on ET, which I understand is Fudgestain (have not yet read his posts here) on this site, but I've always had the feeling that what he wrote were too good to be true.

So, I'm wondering if anyone know what this was all about and what Fudgestain's off-site activities were.

Thanks in advance.
Bumping! :)
 

BearBull Trading

Newbie
6 1
In my opinion statements like "only take trades with minimum Risk:Reward of x " is nonsense. On entering a trade I only know where my "fixed disaster stop" is. The market & exit is dynamic & changes tick by tick. After entering, the "reason" to exit may come at 1 tick or 1000 ticks - the market decides the profit opportunity, not some mythical number a trader is hoping for.