Risk/reward ratio is bullsh$t.

When people ask what is a good risk reward ratio, I think they ask for the wrong reasons.  Risk/reward is not about an expected outcome it is about trade selection or trade elimination. By only taking a trade with an X for 1 ratio you are eliminating trades.  By only taking these types of trades you become better at understanding that risk profile.  Think like a factory worker, they are great at one thing.  It is an important question to ask because it will dictate how an individual trades but it is up to the individual.

The mathematics of risk

No one is immune to the mathematics of risk.  I like futures in that there are multiple reasons for people entering the market.  Not every participants goal is to make money or make money in the context in the way that I want to make money.  But futures is also a zero sum game.  Imagine I am trading against myself.  If I am risking $100 to make $200 than the other side of me must risk $200 to make $100.  If I am risking $500 to make $100 than the other side of me has to risk $100 to make $500.

Whatever you are comfortable risking you should risk that amount but continually going for long odds is difficult for the opportunity costs and length of time it takes for the trade to develop.

The benefit of course is that you can be wrong 4 times and still make a profit but you also must have conviction it you do not get paid till the 9th and 10th or 90th-100th trade.

Professionals go broke taking profits too soon and amateurs not taking soon enough

Trading systems or techniques are designed to return a percentage in a certain type of markets or over a long period of time.  As a trader your goal is to beat that system by a fraction.  The key to that is being flexible.  The flexible part is what makes a trader great.  Hell, it is what makes any person great.  The slight adjustment and were able to do it at the right time.  That is the not so secret, secret of greatness.

I changed up William Eckhardt quote slightly from its original, Amateurs go broke by taking large losses; professionals go broke by taking small profits”, because many of those big losses were gains or the “second” loss.  If you are always taking profits after it hits 2 points what if it goes to 1.75 points and then stops you out or stops you out at break even.  Then hits your profit potential.  Likewise what if you got the perfect price in the perfect situation should you get out at 2 points?

Risk is very important and you must know where you are wrong and where your target is but you also must be flexible and adapt.

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  • tenne144

    good stuff

  • “I made my money by selling too soon.” – Bernard M. Baruch

    Good post @eradke:twitter . Risk/Reward and the potential ratio is an interesting topic. However you define your risk as a trader or investor, if you actually *DO* define it, you’re ahead of about 95% of all non-algo traders in the market.

    P.S. Don’t forget to add your Google+ link at the bottom of your posts. 🙂

    • It is mind boggling that people do not do the simple things.  I think people try to put their seat belt on as the wreck is happening.

      • “I think people try to put their seat belt on as the wreck is happening.”

        Hahah…so true!

  • Switterman

    I am amazed at all the teachings about risk/reward without much talk about the method or buy sell system used. You can trade with 1 to 4 risk/reward over and over and lose a fortune with a bad/unrealistic methodology. Or you could say…. if I had the perfect system for entry and exit, who cares what the risk/reward is.

    • That is in part because there isn’t a perfect system.  But there are traders that can perform better than their system and many, many more that perform worse. 

  • Anonymous

    I think the notion of expectancy has its place in this discussion. If you have a positive expectancy taking small profits then there isn’t a problem. Same goes for waiting for larger moves. It’s when your expectancy is negative that there is a problem. Coming to understand and track your expectancy helps solve this riddle.

    • I honestly believe that a majority of people who trade do not have a realistic expectancy, on both sides.

  • swing trading

    I think the important thing to remember is that the markets(all aspects) are very efficient.  If you want a high winning percentage you must give up something..trading frequency, size of winnners..something.  I have a nifty tool on my site that I love to play with to demonstrate this.  You can can check it out at http://www.swingtraderguide.com/swing-trading-system-simulator  Shameless self promotion 🙂

    • Will check it out. Thanks. 

  • Bottom?!?!?!! Here is the hero…lol: http://chart.ly/itt5bht

12 Responses to Risk/reward ratio is bullsh$t.

  1. tenne144 says:

    good stuff

  2. Jack Damn says:

    “I made my money by selling too soon.” – Bernard M. Baruch

    Good post @eradke:twitter . Risk/Reward and the potential ratio is an interesting topic. However you define your risk as a trader or investor, if you actually *DO* define it, you’re ahead of about 95% of all non-algo traders in the market.

    P.S. Don’t forget to add your Google+ link at the bottom of your posts. 🙂

  3. Switterman says:

    I am amazed at all the teachings about risk/reward without much talk about the method or buy sell system used. You can trade with 1 to 4 risk/reward over and over and lose a fortune with a bad/unrealistic methodology. Or you could say…. if I had the perfect system for entry and exit, who cares what the risk/reward is.

    • Eradke says:

      That is in part because there isn’t a perfect system.  But there are traders that can perform better than their system and many, many more that perform worse. 

  4. Anonymous says:

    I think the notion of expectancy has its place in this discussion. If you have a positive expectancy taking small profits then there isn’t a problem. Same goes for waiting for larger moves. It’s when your expectancy is negative that there is a problem. Coming to understand and track your expectancy helps solve this riddle.

  5. swing trading says:

    I think the important thing to remember is that the markets(all aspects) are very efficient.  If you want a high winning percentage you must give up something..trading frequency, size of winnners..something.  I have a nifty tool on my site that I love to play with to demonstrate this.  You can can check it out at http://www.swingtraderguide.com/swing-trading-system-simulator  Shameless self promotion 🙂

  6. Wise Guy says:

    Bottom?!?!?!! Here is the hero…lol: http://chart.ly/itt5bht

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