This is Why Beginner Traders Lose Their Capital – 2. Risk/Reward
מעודכן
Dear friends,
Thank you for all your responses on the last educational post! I have read all your comments from last time, and while I was preparing this next tip, I realized it’s better to address the most common questions here instead of responding individually, as it will be more efficient.
1. You want to know who I follow. There are many many interesting people on TV, and probably I don’t know all of them. But let me share with you the guys whom I would like to send my most respect: Technician, MarcPMarkets, @tntsunrise. Also I would like to send my special respect to anyone who tries to make really interesting and quality content which can be helpful for community.
The 2nd question was - how to start trading based on my trading strategy. When I started the idea of posting tips that will correct mistakes, I did not have this planned. Also, I am a bit not prepared for this, as it’s not really possible to describe in an article that takes 5 minutes to read how to use this strategy properly. You can observe it when I post trades, but in order to master the trading strategy and use it properly, you will need to learn indicators, to identify a combination of signals from these indicators and how to read them properly. You will need to learn how to use the strategy in different market conditions and pass through real examples. I think the best variant is to combine all of this information in educational course format. It will be the best variant but to prepare it, I will need time, which I have very little.
My purpose for now, is to explain the mistakes I see generally repeating in beginners and how to stop doing them and turn them into a good practice. If you can’t wait and want to learn some classic strategies at least, you will still need to pass through some kind of education resource first in order to learn the at least the basics of trading and TA.
Today’s topic: Why an obsession with Risk/Reward (R:R) Ratio or trade wins percentages is not healthy. How do these two metrics actually correlate?
I see many people being obsessed with win rates and “correct” R:R. I get really odd messages sometimes when I post trades (just an example): “Why do you have such R:R as 1:1 when it should be 1:2 at least because I read that somewhere.“
The simple answer is: this R:R correlated with my strategy, gives me profit and I am happy with its results. Now, to elaborate the answer.
Win rates and R:R are very easily used as marketing strategies. You don’t have to win every trade to be a good trader. You just need to have a strategy that mixes market conditions with the correct type of trades.
Some sources claim that R:R should be at least 1:2. It can be true but let’s try to think about this a bit and do some mathematics:
A simple example: if you have 40% of profitable trades, which risk reward should you have to be in profit?
You need a risk reward ratio of around 1:3 (using whole numbers for the purpose of exercise).
Let’s say we have 10 trade where 4 in profit.
4 profitable trade will give 12 points for profit - 4x3
6 loss trade will give 6 points of loss - 6x1
So with this win rate and risk/reward ratio we are in profit in 6 points.
With 40% win rate even we can work even with risk/reward ratio of 1:2
We win 4 trades, we earn 8 points, we lose 6 trades, and we lose 6 points. Overall we won 2 points. We’re in profit.
But if the risk reward ratio will be 1:1 and the win rate is 40% we'll be in drawdown by -2 points.
As you can see we have the same win rate but different results only because the risk/reward ratio is different.
And that's why people use only the win rate for marketing, let me explain:
It's cool to say - we have 90% profitable trades... but what you don’t see is their risk/reward ratio which can be somewhere around 10:1, because profit targets should be close to entry levels.
Thank you for all your responses on the last educational post! I have read all your comments from last time, and while I was preparing this next tip, I realized it’s better to address the most common questions here instead of responding individually, as it will be more efficient.
1. You want to know who I follow. There are many many interesting people on TV, and probably I don’t know all of them. But let me share with you the guys whom I would like to send my most respect: Technician, MarcPMarkets, @tntsunrise. Also I would like to send my special respect to anyone who tries to make really interesting and quality content which can be helpful for community.
The 2nd question was - how to start trading based on my trading strategy. When I started the idea of posting tips that will correct mistakes, I did not have this planned. Also, I am a bit not prepared for this, as it’s not really possible to describe in an article that takes 5 minutes to read how to use this strategy properly. You can observe it when I post trades, but in order to master the trading strategy and use it properly, you will need to learn indicators, to identify a combination of signals from these indicators and how to read them properly. You will need to learn how to use the strategy in different market conditions and pass through real examples. I think the best variant is to combine all of this information in educational course format. It will be the best variant but to prepare it, I will need time, which I have very little.
My purpose for now, is to explain the mistakes I see generally repeating in beginners and how to stop doing them and turn them into a good practice. If you can’t wait and want to learn some classic strategies at least, you will still need to pass through some kind of education resource first in order to learn the at least the basics of trading and TA.
Today’s topic: Why an obsession with Risk/Reward (R:R) Ratio or trade wins percentages is not healthy. How do these two metrics actually correlate?
I see many people being obsessed with win rates and “correct” R:R. I get really odd messages sometimes when I post trades (just an example): “Why do you have such R:R as 1:1 when it should be 1:2 at least because I read that somewhere.“
The simple answer is: this R:R correlated with my strategy, gives me profit and I am happy with its results. Now, to elaborate the answer.
Win rates and R:R are very easily used as marketing strategies. You don’t have to win every trade to be a good trader. You just need to have a strategy that mixes market conditions with the correct type of trades.
Some sources claim that R:R should be at least 1:2. It can be true but let’s try to think about this a bit and do some mathematics:
A simple example: if you have 40% of profitable trades, which risk reward should you have to be in profit?
You need a risk reward ratio of around 1:3 (using whole numbers for the purpose of exercise).
Let’s say we have 10 trade where 4 in profit.
4 profitable trade will give 12 points for profit - 4x3
6 loss trade will give 6 points of loss - 6x1
So with this win rate and risk/reward ratio we are in profit in 6 points.
With 40% win rate even we can work even with risk/reward ratio of 1:2
We win 4 trades, we earn 8 points, we lose 6 trades, and we lose 6 points. Overall we won 2 points. We’re in profit.
But if the risk reward ratio will be 1:1 and the win rate is 40% we'll be in drawdown by -2 points.
As you can see we have the same win rate but different results only because the risk/reward ratio is different.
And that's why people use only the win rate for marketing, let me explain:
It's cool to say - we have 90% profitable trades... but what you don’t see is their risk/reward ratio which can be somewhere around 10:1, because profit targets should be close to entry levels.
הערה
Imagine:We have 9 profitable trade which will give 9 points of profit but then 1 lost trade will give 10 points and the total result will be - 1 point. Oups.
As an observation, a strategy with risk reward 10:1 is a strategy that all of you know – it’s called HODL.
Another point on R:R
A trade with risk reward of 1:2 - is good and looks much better than 1:1.
But can we use it if we trade on trend reversals/corrections or we trade in range market conditions? 1:2 will not be the best option and, in this case, 1:1 can work better.
הערה
What if we are talking about trend market conditions? 1:2 can be used in the beginning and in the middle of trend. Actually, in the beginning of trend it's possible to use even 1:3, 1:4, 1:5It is only logical - when you have a lot of space for price movements you CAN use risk reward ratios such as 1:2, 1:3, 1:4, 1:5.
So, from this we learn that when you have limits in possible price movements you can either skip trades with a ratio of 1:3 – 1:5) or use risk reward ratios like 1:1 or even 2:1!
Do you see now? It is not ok to create in your mind the idea that all the strategies should be based on a specific R:R. R:R depends on the market conditions and where you start the trade. That is the reality in trading, and to start trades with 1:4 when BTC is 18000$, is just a naive dream.
הערה
Key takeaways: R:R and win rates are flexible and for a good strategy they depend on each other, the market conditions, and of the point of entry in the trade. Just look at the example above to understand how many trades you need to win depending on the strategy. Then, it will be easier for you to follow strategies of experts. It will also make you get rid of the silly idea that all trades must be wins. You win some, you lose some, like in life. If you try to have all winning trades by getting out as soon as you are on red, you will just lose in the long run, not win.I hope you learned something today! Your likes and comments are my only way of understanding your interest in this topic, please participate, and please keep criticism constructive.
P.S: As much as I would love to answer all your questions, sometimes my time is short. I do read them all, and I will try to address the ones which are asked the most, in the beginning / end of each new post.
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