The reward-to-risk ratio: Is lower actually better?

Discussion in 'Risk Management' started by Inspiritsa, Aug 13, 2020.

  1. Hi traders. I've been active in FX for a few years now, but have had a small losing streak recently. Although the setups were quite promising and interesting setups, my stop-losses were too tight and TPs too wide. The reward-to-risk I was targeting was around 5:1, sometimes even higher.

    After a few trades hit SL, I came to the conclusion that the main problem was the very high R/R I was aiming for. Had I traded a ratio of 1:1, all of the trades would be closed in profit.

    So what is the reason behind targeting a higher R/R ratio in the first place? We often hear that the win-rate determines the R/R ratio you should be using, but in essence, it's the R/R that determines your win rate. A lower R/R ratio will obviously lead to a higher win rate.

    I would always choose smaller, more consistent profits than taking dozens of (losing) trades until one of them hit a jackpot R/R ratio of 5:1, 10:1 or more.

    I would like to hear your thoughts on higher vs lower R/R ratios. Are higher R/Rs worth it? Currently, I doubt so.
     
    SimpleMeLike and murray t turtle like this.
  2. DevBru

    DevBru

    The best way to calculate the best risk to reward for your system is backtesting.

    Just picking a number because you like it doesn't work. I have 2 different trading systems and both perform best when i stick to a 1:1,5 risk to reward. When i see increased volatility i might move my target further out with a trailing stop.

    I didn't just pick 1:1,5, i came to that number by doing a lot of test. That is the only way to calculate the risk to reward that fits your system.
     
  3. tomas262

    tomas262

    I think it really does not matter to much eventually
    If you have an edge you can use 1:1, 1:2, 1:2.5 ... as you increase your Win% goes down in a linear fashion and losing streaks will grow. BUT it is also related to market you trade + timeframe ... some markets give 2.5R easily while others not so you have to backtest properly
    I cannot daytrade below 1:2.5 .. my mind just whispers that 2 times risk is not enough :D ... when the system and market works well I want the equity to sky-rocket but there are weeks when I end up breakeven or in drawdown while 1:2 would be hit just fine
    Might be better to have 2 targets 1:1.5 + 1:2.5 to cover such periods but currently too much risk to trade 2 lots :rolleyes:
     
    Last edited: Aug 20, 2020
  4. Bad_Badness

    Bad_Badness

    As the others have pointed out, there is a sweet spot, that changes. Like any complex system, rigid stuff can be the round peg in the square hole. I would add that once you test for the sweet spot, test the edges also. Conditions change, and so should you.
     
  5. Tradex

    Tradex

    That is always the correct answer.

    The ratio stop-loss/target must be determined by the trading rules of the system and the backtest.
     
  6. Tradex

    Tradex

    In that case trend-following systems (with their 35% winning rate or so) will not suit you, as the profitability of these systems depends on a few large winning trades.

    And to answer your original question there is no good or bad risk-reward ratio.

    However, from my own personal experience and testing, higher risk/reward ratios (you risk $1 to earn $2 for instance) tend to produce more robust systems (but relatively bigger drawdowns as well).
     
    Last edited: Aug 22, 2020
    murray t turtle likes this.
  7. %%
    Mostly true;
    but stock/sector/tech trends can easy do better than35%. It varies from week to week/year to year.Some like smaller profits with low or no commissions + some like. larger profits; I like both..................................................No commissions helped.
    I see his points but dont think of any profits as ''jackpot''/a gamblers term,not applicable to trading/investing. I have gone to plenty of ''potluck dinners/LOL''
    WE gambled for quarters in pool halls as kids/commissions were too hi back then to trade.
    Prefer to aim for larger profits=======@ end of week I will take a small profit rather than nothin'[AND remember the rule; never let a profit turn into a loss/a much better weekly rule than daily]And I dont auto sell or auto buy every week.
     
  8. Tradex

    Tradex

    Oh sure, no doubt, the 35% winning rate is just an average.
     
  9. biduece

    biduece

    It's psychologically easy to trade higher winrate and lower R/R system. also you will have smooth equity curve and low DD. but, both kind of systems have it pros and cons I believe.