Trader Essentials III - Risk Reward Ratio

Risk Reward Ratio -  What kind of cool indicator is that? Must be a direct indicator of where I need to get in and out? 😅 Or does it?

Unfortunately no - it is not a cool indicator and yet THE WONDER WEAPONs of every trader. Because the CRV is not an indicator, but the RISK-REWARD-RATIO.

In the end it is pure mathematics. Because the RRR tells me how much I win and lose on my trade. A small example - if I risk 100 points with a DAX setup and my price target (TP) is 200 points, my RRR is 2:1, so I have twice the potential to win compared to my possible loss.

The RRR is the reason why low hit strategies can often be more profitable than higher hit strategies - simply because my average winning trades yield much more than my losers.

To make it even clearer, consider the following example:
We get the chance to play a "coin toss game" - the average chance that we win is therefore "only" 50%. But if we would lose 10€ for each number that falls, but win 15€ for each "head" - I think quite a few would be at the next ATM to get some "play money" =)

Or another example:
We play with one die. With the numbers 1-5 we lose 10€ each. But if we roll 6, we win €100. Despite the extremely below average hit rate (just 17%), we win in the long run through our extremely good RISK-REWARD-RATIO

 

This is exactly why it is important to trade setup with the highest possible RRR. Because one thing is clear: If you combine that with a halfway decent hit rate, you just have to be consistent in your strategy to be on the right track in the long run. Because one thing is also certain: There will always be loss trades.

The art lies in accepting these, but also in consistently carrying out his trading,

Here again a small calculation example - because you should be aware of this.
Let's assume a hit rate of 40%. That means I lose out of 100 trades, a full 60!
But I only handle setups with a RRR of at least 3.0.

Each setup is traded with 1% risk. So if I have 60 losers, I lose 60%. However, with my 40 winning trades, I gain 120%!
That makes an average of 0.6% profit per trade.

The difficult thing is that I don't know when my losers and when my winning bikes are coming. Of course, this can be a mental burden for example with 5 losing trades in a row. Nevertheless, this strategy would be 50% more profitable, i.e. a strategy with 70% hit rate (which you have to manage first!) and a RRR of 1to1. (there the expectation would be 0.4% per trade),

I hope that I could help you a little bit and above all I could open your eyes that it does not necessarily depend on the hit rate. Much more important is the possible win (chance vs. risk) - by the way, this is also a reason why so many people play the lottery (low stakes, extremely high winnings on a hit) even though the chance of winning tends towards 0, as is well known.

Are you looking for a strategy with a high hit rate and good Risk-Reward-Ratio at the same time?

Then check the the RISK REWARD BEAST STRATEGY out !.  =)

Michael – Team PimpyourTrading

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