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I am a software developer, so I use my programming skills to create various tools that help me make trade decisions, and even automatically perform the trades. I have been mostly paper trading and just studying the results and trying to formulate some strategies for real trading.
Anyway, I often read "experts" always say to use a high reward to risk ratio. 1.5 to 1, 2 to 1 or 3 to 1, etc.
However, to me this seems like bad advice when not coupled with winning percentage.
Assuming trade size is always the same, I am curious to hear what people think about this. For example:
1.5:1 ratio requires 40% win rate to break even.
2:1 requires 33%.
3:1 requires 25%.
0.5:1 requires 67%.
0.25:1 requires 80%.
and so on....
But all the experts would always say to never do a 0.5:1 ratio. But why not? If I can produce a win rate higher than the break even rate, then why not?
The way I see this is that with a high ratio/low win pct, psychologically, it is harder to deal with the losses. But if you miss a trade for whatever reason, most likely you missed a loss.
On the other hand with the low ratio/high win pct, psychologically it is a lot easier since you see all the wins, but if you miss a trade, most likely it was a win.
In addition to all of this, I am curious to hear opinions on where you draw the line between a statistical trend vs margin of error.
For example, (reward risk ratio aside) if you do back testing and I find that a specific strategy wins 55% of the time, would you consider that a valid statistical trend?
How far above the break even winning percentage would you feel comfortable in making trades?
Personally, I have been aiming for about 15% above break even, although I am struggling to find much above 10%.
Just curious what people think about all this.
The following user says Thank You to gurji for this post:
The most important thing for me - is the Win/Loss Ratio - NOT - the Winning Percentage. While I have a very high winning percentage with my Algo's - a trader can still do well trading with a VERY LOW - Winning Percentage. Personally - while I am showing a Minute chart - that is NOT what I use. Notice the Wins and Losses. Not a lot of Wins - or big Losses - but a lot of Break Even Trades - in which you would basically lose Commission ONLY. Now look at the Strategy Performance Summary - with the Net and Gross Profits - which shows it did fairly well. By the way - this is for 10 days. Now - look at the Total Trade Analysis chart. Notice the Percent Profitable - is only 17.08%. Now look at the Average Winning Trade and Average Losing Trade and the Ratio Avg Win/Avg Loss. This shows - just because the Percent Profitable - is really LOW - money can still be made.
I don't participate in forums very often - but just happened to see your post.
The following user says Thank You to Doob for this post:
As you possess programming skills, you should have the capability to determine what is most suitable or optimal for your risk profile. Personally, I prefer to search for and develop strategies that target a substantial reward, as the expenses associated with conducting business can nullify your advantage when seeking modest rewards. It's not feasible to discover significant rewards within short timeframes, so you benefit in terms of time commitment by avoiding the pursuit of your edge within the erratic price fluctuations that occur during intraday trading periods.
During your exploration, make an effort to assess the balance between the maximum attainable reward and the necessary winning percentage to attain that reward. Endeavor to pinpoint the minimum winning percentage required to attain a substantial reward. You'll discover that when you set your sights on a specific reward, achieving a low win rate can be challenging. This juncture of tension is what you should aim to identify for your chosen financial instrument. By undertaking this analysis, you will come to the realization that pursuing a modest reward can be unproductive and time-consuming, which is where many day traders ultimately falter.
While I do some Trend trading - I prefer Scalping. Even before I started coding - 25+ years ago - I always preferred Scalping. Maybe it is because I grew up in Montana - both my brothers-in-law - were American Indian - they taught me how to Scalp - the right way - LOL. We were hell on tourist driving though the area - LOL. I grew up on a Indian Reservation.
I do some Trend trading - but mostly Scalp trades - and I have to meet my Net Daily Goal (NDG) in Dollars - within the first 2 hours of the Market Open - then I am done for the day - whether I reach my NDG or not. For me - it is all about Discipline. I have a Motto - "Discipline plus Simplicity equals Success".
Many years ago - in the early 2000's - if I recall - maybe 2003 - I had a Booth at the Traders Expo in Las Vegas - in which I traded - Real Money - Scalping - as traders came by the booth. The last Traders Expo - where I had a Booth - was in San Diego - I believe it was 2006 or 2007 - but I am getting old now - memory not like it was - LOL. And - the owner of a Major Trading Software provider - NinjaTrader - was in my booth - part time - as I again - traded Real Money - Scalping - in front of traders - as they came by the booth - and I was Profitable. After the Traders Expo - I put on a multi day paid Seminar - at the hotel I was staying at - just North of San Diego. On the final day - which was on a Monday - my broker - NinjaTrader - had set up a few (3 or 4 if I recall) Trading Accounts for me - so the participants in the class - could actually trade - Real Money - MY MONEY. Of course - I wanted each trader - to make money - but Win or Lose - I wanted them to have an experience - actually trading what they learned. They were kind of shocked - when I told them they would be trading Real Money - on My Accounts - talk about Pressure - on them - not me.
All traders are different - some do great Scalping - some Trend trading - and probably the majority end up going out of the trading business. And again - for me - I was up and down with my trading - early on - then I finally decided - I needed to become more Disciplined - and keep things as Simple as possible. I developed some VERY Strict and Specific RULES - and learned - as long as I followed my Rules - Success finally came.
Here is an old eBook I put together many years ago - Free for All. Some traders may find it boring - or total BS - but hopefully it will help some traders.
The charts show the results for 10 trading days.
The following 4 users say Thank You to Doob for this post:
Hi, thanks for the reply. I completely understand that profitability is possible with a low winning pct and a high win/loss ratio. I get that, but what I am asking is if you can achieve the same profit with a low ratio and high win pct, what are the pros/cons of each way.
In your reply, you mentioned that Ratio is the most important. But overall, the combination of the 2 (assuming trade sizes are the same) is what determines profitability.
40 wins of $100 each
60 losses of $50 each
Ratio 2:1 with a 40% win rate
Profit $1000.
OR
73 wins of $50 each
27 losses of $100 each
Ratio 1:2 with 72% win rate
Profit $950
(Pretend the profit is the same. I didn't want to sit and calculate 2 different ratios that would be perfectly equal. $950 and $1000 - close enough).
Hi, thanks for the tips. I have been attempting the lower timeframes, 5, 15 min charts to grab small amounts. When I first started, I even toyed with the 1 minute charts. The more I do this the more come to realize that the higher the chart timeframe, the more predicable the movement.
The following user says Thank You to gurji for this post:
Van Tharp had a lot to say about this. Total agreement with you that risk reward and win loss are factors in determining a good system.
Behavioral Economics has demonstrated that 1 adverse is equal to 10 positives, so your brain has a hard time accepting a high level of losing trades. So if you are selling snake oil best to say 2 to 1 winners or something like that.
Van Tharp developed something he called a System Quality Number so that dis-similar systems could be reasonably compared.
But a simple numeric rating based on, say 100 trades with a given system would make life very difficult for all the system vendors!
I like a lot of Van Tharp's work, but his System Quality Number is IMO pretty useless. Originally he had square root of number of trades in it, until it was pointed out that more trades would make system better, all by itself. Then he hard capped it the square root of 100 trades, which was arbitrary. He might have then refined it more, but I gave up on it.
Simple metrics are best IMO. One educator actually has some special "index" that gets better with higher losing percentage!
