# Risk to Reward myths and trading strategies along with tips on MM

I promised to explain to Jasmine about why the idea of her trading strategy with a RR of just 1 and a success rate of 70% could be improved and optimised.

Please don't think that with 70% win ratio an RR of just 1 you cannot make money - as long as your MM is good - you will make money - BUT - you can make a lot more and improve it.

At the moment from what I understand Jasmine looks for a target on a trade opportunity and gives approx the same amount of pips as a stop - as the target .

So if her target on say a buy is 45 pips - her stop will be around the same  - and if the target is 90 pips - the stop would be around 90 pips.

Her theory is 2% stake - outcome she either wins or loses 2% - clear cut - and stake size would be smaller on larger targets and larger on smaller targets - ie 100 pip stop say - 1lot - 25 pip stop and target 4 lots - as same stake %.

Now lets look at a statistical minimum of 30 trades - enough to explain etc.

In theory she will win 21 trades and make 2% on each trade - and lose 9 trades and lose 2% on each one

Result - plus 42% minus 18% - result on 30 trades - increase in account by 24%.

Now that's great and 24% increase in your account in a month is very good - in a week excellent - in a quarter - average.

So to improve it - decrease stop sizes and even target sizes - don't increase them looking for say 200 pip targets - look for 20 pip targets - but not with 20 pip stop - ideally under 10 pips stops.

If you look at any pair and say a 30 min or hr chart - you will see every day moves of over 20 pips that could be taken with 3 pip stops - when you fully understand the market.

So of we can get targets of 20 pips and stops of 10 pips  - then RR 2

Lets say win ratio goes down to 60% - ( Sundaram and FX bear will laugh at so low win ratios ) - the results are

On 30 trades new result - 2% stake - 60% success

21 trades at 4% = 84% and 9 losses at 2% = 18%

New result 84 -18 = 66% on 30 trades compared to 24% - massive improvement.

When you get down to scalper level - ( this can be verified by at least 10 traders in this forum - with live accounts) -

So 30 trades with 12 pip targets and 4 pip stops - not many pips - but result on your account a 2%

21 winners at 2.5 x 2% = 21 x 5 - 105% - 9 losses at 2% = 18%

Net result  105 -18  = 87% result compared to 66% and 24% as at present on a RR of I

Jasmine - forget the 100+ pip targets - get down to the 15 pips - there loads of them ;-))

Regards

Peter

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Comment by ala bala on March 1, 2013 at 8:53am

This comparison is incorrect. You compare a strategy with 40% market edge (70% win/loss ratio at 1:1R/R) with a 280% market edge (70% win/loss ratio at 3:1R/R). Actually, if the market edge is the same, the outcome will be almost the same as well in %profit no matter what RR you apply. Almost, because the cost of trade (spread) distribution will worsen the outcome when switching from 100 to 12 pip trades.

Comment by Peter jcp on March 1, 2013 at 9:01am

Sorry Ala - would disagree with you - cost of spreads are immaterial when they are under 2 pips- and all figures are net - ie after spread cost. You are correct to say the 280% market edge is better than 40% - that's taken - but when you work on net figures not gross - spread costs are out the equation.

I pay my broker between 3k and 8K per month and I am an ex accountant and dont worry about the costs - I am more concerned on what I make - I would sooner pay my broker 10k amonth and make say \$40k ( only 4 times as much) as pay my broker say just 2k per month and make say \$20k - ie the cost is only a 10th - but so what I only made 20k against 40K - I want the larger winnings ;-))

Hope I have explained it sufficient but please any more queries please raise

Regards

Peter

Comment by ala bala on March 1, 2013 at 10:20am

Anyway, the spread is never "immaterial" under some nominal value, because its weight on the trade is relative and is affected by the time frame you trade on. It is just a pure math to see, that switching from 100 to 12 pip profit will increase the cost of trade 8,33 times. So you will have to counteract that effect with a better edge, better strategy and better win/loss r/r ratios.

Just like you do, if you really can achieve 70% w/loss ratio at 3:1 R/R, which is awesome.

Comment by Peter jcp on March 1, 2013 at 10:53am

Hi Ala - I think the incorrect comparison is fair and comes about because Jasmine was happy to look at only RR's of I on all trades. Now I have suggested that can be improved  - but I would agree to get an RR of 3 continual is difficult - and is only possible with stops normally under 10 pips - my everyday stops are 4-8 pips depending on the pair.

I have had RR's of 15 plus and I think Chris Capre mentioned before he had them at 30+ - but all the ones I have over 5 - are with reduced stake levels left to run as a"free trade" with the stop in profit etc. So if price is up say 50 pips from entry and it reverses say 20 pips - I am OK as I would still be in profit and then - I either end up getting stopped out - or its keep going and can even end up as a trade making extra 100's of pips/

And with regards to the spread cost - my calculations are all net - so even though you have higher broker cost - the additional profits from all the extra trades - pay for it and you end up with more money.

Also even with a lower win ratio say 60% you are still more profitable with an RR of 1.5 or 2 than having a very high success rate of 80% and only having trades with RR's of only 1 In fact we know some professional might only have a 35-45% success rate - but when they win the RR's are all over 4+ and so it covers all the losses and makes them good profit.

Not for me - but I think we would agree the main thing is a profit - and then its a case of optimizing it within your trading framework and strategy.

Regards

Peter

Comment by Peter jcp on March 1, 2013 at 11:35am

Forgot to mention - and someone as asked me why 15 pip trades with a RR of 1 than 100 pip trades with a RR of 1 - if thats the way Jasmine wants to carry on. Well its because she can do more trades - and this is a numbers game - so of she can do say 30 trades in a week rather than a month say - then she will make more money.

Its not overtrading etc on 15 -20 pip targets - there are loads every day - but there are not many 100 pip trades every day. Traders have listened to the broker cost myth and overtrading lark for far too long - I dont suggest 30 -50 trades a day - thats too many - but when you are experienced - 5 -10 trades over say  4-8 hr period is hardly pushing it with smaller targets.;-))

Comment by Jasmine C on March 1, 2013 at 11:54am
Thank you Peter for taking the time write this post. I appreciate your comments and your analysis. And thank you Ala for your response.

Where I take issue is with your definition of R/R. For me, it is an input to my trade - it doesn't change. When I look over my account history I either see +2% or -2% (approx). Which means I can state with some degree of certainty that a particular strategy produces a 70% win ratio. When I fully believe in that strategy and I want to make more money I simply raise my trade value from 2% to 5%. All other factors remaining constant (same simple strategy, same R/R) my P/L increases.
Remember, my strategy is completely unambiguous. It follows a pattern, it has an entry and an exit and while those patterns do appear on lower timeframes and I could trade those with smaller ranges, as Ala points out the spread then becomes a more significant cost (on a 20 pip risk, spread is 10% of your risk!). Also, it doesn't suit my trading style to be in and out of trades all the time. I have a day job. Looking at H4 is incredibly relaxing and stress free. I used to think I was missing out. That I needed to be making more trades to make more money. How wrong I was :-)

Back to your R/R. I still believe that if you take a trade with a 20 pip stop loss and "manage" it all the way to a 100 pip profit with for example a trailing stop - this is NOT the same as a 5:1 risk/reward. It is a series of 5 1:1 trades. That for me is the key difference.

The more variables you have, associated with your trading, the less confidence you will be able to place in figures such as win:loss ratio. These have become a factor of your ability as a trader to manage your trade.

This is why there are so few successful retail traders. Because those professionals who do make money are essentially telling others "think like me, feel like me, make instinctive decisions like me" and that is how you will make money. I am just saying you don't have to think like me, you don't have to have my emotions (you do NOT want my emotions, trust me!) you don't have to make any instinctive decisions - you just have to play the strategy.

If you can write on a piece of paper exactly what your strategy is. And you implement it exactly the same each time I would say that is unambiguous. I read somewhere when you're trade gets to 15-20 pips in profit move the stop. Which is it? 15 or 20? I'm 16 up. What do I do?? You think it doesn't matter? It matters.

Sorry for the brain dump. Better get back to the charts - I think I missed a few entries this morning! Watching my little girl at a school play - so not too disappointed :-)
Comment by Peter jcp on March 1, 2013 at 2:10pm

Hi Jasmine - I think that is a very sensible answer you have given me - and I accept your logic - that if I can have a 70% win ratio and maintain it for say hundreds or thousands of trades - I will them just raise my capital to say 5% etc etc etc.

However - its flawed for a start - and I have been caught out with the flaw myself approx 4 yrs ago.

A 70% win ratios is good - some would say excellent - but I know it can be achieved long term.

But here's the problem on say 100 trades you will have 70 wins and 30 losses and on 10 trades 7 wins and 3 losses - BUT .......

The ratios do not stay the same and you will have at some time a "black swan" event .

For example it is possible in one day or week to have 7 or 10 bad trades in a row - and still maintain your 70% success rate. That will scar you - it did me and if you were on 5% stake you could lose over half you account in a week and then that means you to need to be 100% successful for numerous trades to get back to the previous level.

So the answer to that really is don't go over 2% stake - my trades normally up to 5 full lots are under 1% of capital - but because I have the key on higher RR's - its still possible to have 5 -10% result days -

I totally understand re your hours - I have had this discussion before with Lisa - and busy mum cannot spend full time - or can they ??

Its so important to get use to losing - you need to be able to lose and just get on with it - thats why when I lose - I want to know in 10 minutes not 4 hrs or a day - what a waste of time ;-))

So after 10 mins I am normally up 5 -10 -15 pips and bingo there's your RR of 2 or 3.

Yes the 4hrs is relaxing and comforting - and will set you up the wrong way so easily without you even knowing - the market makers love traders who dont mind being wrong 50% of the time and have patience - -its the markets "bread and butter" -

There are many successful traders who trade only off 4 hr plus charts - but they have to be happy with investor results - ie 30 -70% per annum - great if you have half a million - but even with that amount I would prefer 150 -250% increases per annum

Good luck on the journey and just try and get some trades with RR;s of 2+ ie 20 pip stop 40 pip target or even 30 pip stop 60 pip target - but then every time you watch a movement of say 12 -20 pips in 15 mins - think of me ;-))

Have a good day

Regards

Peter

Comment by Jasmine C on March 2, 2013 at 7:12am
Hi,
Thanks again for your response. I will concede that if you take a trade with a 10 pip stop loss and manage it to a 100 pip reward by say, moving your stop every 10 or 20 pis that this constitutes a 10:1 reward. It's a great trade. But it's also a trade with an extremely low probability. How often do you see price move _any_ sort of distance without at least pulling back a little way.

I don't know whether this is broker manipulation to keep stopping people out so they make more trades but that's just the nature of price action.

As I said I trade a pattern. I'm not looking for 20 pips or 50 pips or 100 pips. It's a pattern. And as we all known these markets are fractal and my patterns appear on the lower timeframes as well. at times I have considered going down to the H1 or even M15 to look for a trade when things aren't happening higher up. But at the moment the higher timeframes seem to fit my style.

What is interesting, possibly, is that I decided to take a look back over the last dozen or so trades I took ( I take a screen snapshot at close just so I can see how that trade evolved - I started blogging a couple of weeks ago so you can see some over at jasminefx.com). Quite a few of them didn't go more than 10 or 20 pips in the red before hitting my target, a hundred or so pips away. So they all arguably could have been 5:1 or 10:1 trades. But then a EURJPY breakout last Monday (which I'm sure we all took!) went 100+ pips against me before crashing down to my TP for +300 pips

I'm sure my strategy could be improved. I probably do not need the 100% risk. It's just a cushion. It never really gets used, and in fact, when price moves more than 25% against me, that trade generally loses.

But what I am certain of is that if price is heading towards my target and I try to cover myself by moving my stop up, I would never have made all those 100+ pip trades ( these are volatile times so I don't consider 100 pips to be a big deal. It's just another trade )

Anyway - if im bored maybe I'll pop down and see you one of these days on the M5!

Thanks again
:-)
Comment by Jasmine C on March 2, 2013 at 7:18am
Just finally, I think people move their stops because they don't really have a clear view of where price will go to. They're just kind of hanging on in the hope its going to be a long and fast ride.

For me, I have a very clear idea of my target. When price gets there I take off the trade. And until I does I leave it on.

You know what, I think I'll start posting a 25% risk this next week - see what difference it makes :-). And lets hope for some further EUR and GBP weakness!
Comment by pandora on March 2, 2013 at 7:43am

Not agree ,,depending of trading style

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