This is Why Beginner Traders Lose Their Capital – 2. Risk/Reward

This is Why Beginner Traders Lose Their Capital – 2. Risk/Reward

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DLavrov

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 – 4×3
6 loss trade will give 6 points of loss – 6×1
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.
Source: TW DLavrov

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