Do you Understand the Risk to Reward Ratio in trading

By | May 18, 2013 10:15 am

Many traders I have interacted with every first question comes up “Bramesh What is Risk to Reward Ratio your system gives, I ask what is your expectation most of amateur will answer at least 80%.” I just smile and try to explain the why traders looks for such rosy percentage.  We just need to understand the basic maths behind trading.

Most of professional traders are likely to lose atleast 35-35% of their trades and some even 60% of time. But still they make money, How is this possible. Let me elaborate with the same in remaining part of article.

Before you start trading make sure you and your mind understand losing is part of trading and losses will be there. So do not ge disheartened when you see losses and keep sticking with our losing position.

Losing is good if you’re cutting your losses quickly and understand that by doing so you’re simply preserving capital and that your winning trades will pay for your losing trades with profit left over. This is the power of your average risk reward ratio over a series of trades coming into play; we will see this in example below.

Mr X is a professional trader and a quiet successful one. But when someone ask his Risk to Reward ratio it comes just  50% ie. If he takes 10 trades 5 end up losing but still he makes good money.So how is this possible.

This image shows us that profitable traders can lose more trades than they win and still come out very profitable over a series of trades. Thus, losing money on any one trade should not concern you:

As seen in above image summary is mentioned below.

Total Profit:17,000 ie.17% Gain

So even if you loses 50% of time Mr X makes 17% gain. So trick is to lose less and stay with your winners.

As we can see in the hypothetical track record above, the math shows us that even while losing 50% of our trades, if we let our winners run to  and cut our losses small, the profits will take care of themselves.The “secret” is keeping ALL your losers at 1R or less and ONLY trading when our SAR, Trend Trading strategy  gives signal.

If you follow an actual plan, losing is easier to accept, because at least you had a plan and a roadmap as to what you were trying to do; the brain then sees it as more logical and thus you’re less likely to experience apprehension or fear. You will also avoid interfering with a lot of your trades which can produce unnecessary losses.

Mastering our SAR, Trend Trading strategy and “trusting” it: master it, own it and believe in it.