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BEST Risk to Reward Ratio for Day Trading Stocks and Forex? - Forex Day Trading - YouTube
Channel: TRADING RUSH
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What is the best reward risk ratio? What should
you use? What reward to risk ratio is best
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for your trading strategy. Lets find out!
Hopefully this video will help out the new
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traders.
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Use reward risk ratio higher than one, you
have probably heard that somewhere before.
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But using a very high reward to risk ratio
can turn your profitable strategy into a money
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losing machine. Let me explain.
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If you are new to trading, and if you have
a trading strategy that produces a win rate
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of higher than 50 percent with 1 is to 1 reward
risk, do not use a reward risk ratio higher
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than 1. If you do, you will increase your
chances of losing trades multiple times in
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a row. Let me give you an example.
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Lets say, you enter a long trade, and you
set the stop loss according to your stop loss
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strategy. Now, to get a 1 is to 1 reward risk
ratio, you simply set your profit target at
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the same distance as your stop loss. As you
can tell, this is a 1 is to 1 reward risk
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trade.
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Now, every trade is like a coin toss. The
price will either go in the upward direction,聽or
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in the downward direction. And聽with a reward
risk of 1 is to 1 including commission, there
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is a 50 50 chance of winning as you will either
lose or win the same amount.
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But,聽If your trading strategy has a win rate
of 55 percent. In the long run, you will be
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profitable. You will win more times than the
number of losing trades. That's Obvious.
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But if you try to increase the profit potential
to get the 2 is to 1 reward to risk ratio,
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you will actually decrease the win rate of
your strategy, because price will have to
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move twice the distance than before. So your
strategy that was giving 55 win rate with
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1 is to 1 reward risk ratio, no longer gives
that win rate. The new win rate will be much
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lower.
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Some beginner聽traders don't see this fact,
and start trading with reward risk ratios
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that are very high. Like i said before, by
using higher聽reward risk ratios like 3 is
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to 1, beginner traders are increasing their
chance to get multiple losing trades in a
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row. This can lead them into believing that
their strategy doesn't work at all. Their
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strategies do work, but only with their proper
reward risk ratios.
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Then what reward risk ratio should a new trader
use?
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Since many聽beginner traders lack experience
to analyse the overall market direction, it
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is recommended that they use a simple but
effective trading strategy, like the MACD
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strategy that gives around 60 percent win
rate, and with that use a 1 is to 1 reward
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risk ratio. That's right. Using a reward risk
of 1 is聽to 1, will help you win trades more
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consistently than you would with a higher
ratio. This will also help with the Trading聽psychology
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as a beginner trader. Not losing multiple
trades in a row will keep your mind stress聽free
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while looking for聽new opportunities.
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Once you are comfortable with 1 is to 1 reward
risk ratio, try increasing the profit potential
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with 1.5 is to 1 ratio. This will slightly
decrease the win rate of your strategy. But
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by using this ratio, you will make money even
if you lose one and win one.
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You have probably seen a similar chart that
shows the win rate required to break even.
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As a new trader, Instead of looking only at
the break even percentage, you should also
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pay attention to the probability of losing
multiple times in a row with different reward
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risk ratios. Here's a modified chart. As you
can see, the higher the reward risk ratio,
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the higher is the probability of getting multiple
losing trades in a row. This is because, price
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has to travel more distance to reach your
profit target, than it has to reach your stop
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loss. And as you already know, most of the
time market is moving sideways. To get a very
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good reward risk ratio like 3 to 1, the price
has to be in a very strong trend, and that
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doesn't happen all the time.
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So what is the best reward risk ratio in trading?
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Well, it depends on what you are trying to
achieve. If you are looking for consistent
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profit, you reward risk ratios between 1 to
1 and 1.5 to 1.
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If you can handle the possibility of losing
multiple trades in a row, use reward risk
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ratios that are higher than 2.
Since most Human Minds would prefer winning
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instead of losing, it is better to use the
lower reward risk ratios, especially if you
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are just starting out. This way, your mind
will be at peace while trading, and you won't
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get paranoid by looking at the list of losses
on your trading platform.
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You have probably seen some traders move their
stop loss to break even once the trade crosses
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1 is to 1 reward risk ratio. They do that
to remove the possibility of losing the trade
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when it has already crossed the 1 is to 1
reward risk ratio. Unless there is a strong
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catalyst that is moving the price in a strong
trend, the probability of the trend reversing
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is higher, since most of the time market moves
in a range. By moving the stop loss to break
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even, traders are simply eliminating the chances
of losing money if the direction of the trend
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reverses, before the price reaches their higher
reward risk ratios like 3 is to 1.
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What about trailing stop loss? is that better?
Well, it depends. There are different ways
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to trail the stop loss. If you trail your
stop loss very close to the price, the price
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will touch your stop loss, since most of the
time price won't reach your profit target
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in straight line. But by trailing your stop
loss, you will get consistent small profits
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and small losses. With a trailing stop loss,
If the price moves strongly in your favor,
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you will get a good reward risk ratio. If
it immediately goes towards your stop loss,
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you will lose your original risk. But if the
price goes in your favor, and does some choppy
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price action before hitting the profit target,
you will make a small profit with the trailing
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stop loss.
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Here are some Key KEY TAKEAWAYS from this
video.
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Number 1. Reward Risk Ratio and Win rate,
are inversely proportional to each other.
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If the reward risk ratio goes up, the Win
Rate goes down. Similarly, if the reward risk
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ratio goes down, the win rate goes up.
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Number 2. Since Most Human Minds prefer winning
instead of losing, as a new trader, you should
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use a reward risk ratios that are lower than
2 is to 1.
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Number 3. The Recommended Reward Risk ratios
for consistent profit are 1 is to 1, 1.5 is
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to 1. And if you are a little bit experienced
in analyzing the overall market direction,
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maybe 2 is to 1.
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That's all. Now you know little bit more about
the reward risk ratios. Hopefully, this will
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help out the new traders with choosing the
right reward risk ratios.
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