Do you always track your trade?
Do you know your risk-reward ratio?
If the answer is yes, then you beat the 90% of traders out there.
Good for you!
But not all traders my idea about risk-reward ratio, they do not do it because they do not know.
If you are one of those who have no idea about the risk-reward ratio. Then this article is for you.
When it comes to risk-reward ratio this is the measure of how much potential reward you can get for every dollar you risk.
In trading platforms, we normally use dollar not peso, so it is easier to explain if I will use dollar as an example.
Suppose my risk reward ratio is like "1: 3" which means I will risk $ 1 for a potential reward of $ 3.
In the 1: 5 risk-reward ratio, I would risk $ 1 for a potential reward of $ 5.
It's easy isn't it?
The ideal risk-reward ratio used by traders is the 1: 2 ratio. $ 1 risk for a $ 2 dollar profit.
Whoever is a professional trader when you ask what the best risk reward ratio that is recommendable is what will be thrown at you.
But the thing is there is a drawback to using the risk-reward ratio.
Let me explain.
For example, you trade Ten times and use a risk reward ratio of 1: 2. Which is the recommended of every traders.
But the winning rate on the 10 trades you make is only 20%.
That means in 10 trades you have 8 losers and 2 winners.
Since you finofollow 1: 2 risk-reward ratio, this is the calculation
Total gain = 2 * 2 = $ 4
Total loss = 1 * 8 = $ 8
Net loss = - $ 4
Loss!
So what does it mean?
Do you need a higher risk reward like 1: 5 to be profitable?
No!
This means that the risk-reward ratio will not work alone, you also need a high win rate. Even if your risk reward ratio is 1: 1 or 1:05, as long as your win rate is high, you are still profitable in the long run.
But win rate will not work alone either, it's the combination of risk-reward and win rate.
You need to combine them to find out if the strategy you are using is profitable in the long run.
And here comes the expectancy.
This is the formula
E = [1+ (W / L)] x P - 1
E = Expectancy
W = Size of average win
L = Size of average loss
P = Winning rate or percentage
Let me give you an example so that we can better understand.
For example, you track all your trades and of the 50 trades you make, 30 are winning trades and 20 are losing trades.
This is actually a realistic number, because there is no trader with a 100 percent winning trade. So let's stick with it.
If in the 50 trades you make you have 30 winning trades it means your winning rate is 60% (30/50)
Let's say the profit you get in 30 trades is $ 2,000. Let’s take the average $ 2,000 / 6 = $ 333.
As for your losing trades because you lost 20 times with a total of $ 1,200, let's also take the average $ 1,200 / 4 = $ 300.
Now, let's put it in the formula
E = [1+ (W / L)] x P - 1
E = [1+ ($ 333 / $ 300)] x 0.6 - 1 = 0.26 or 26%
In the example I made it appears that Your trading strategy expectancy, in the long run, is 26% a positive expectancy.
This means that in $ 1 risk per trade you will get a return of 26 cents.
I only calculated for 50 trades, the more trades the better. If you can I calculate over 100 trades to 200 better.
Here you will find out how effective the trading strategy you are using is by getting a positive expectancy.
"Positive expectancy is defined as how much money, on average, we can expect to make for every dollar we risk."
So what is more important in trading your risk-reward ratio or win rate?
Good question. But the answer is none of them.
More important is Positive expectancy.
Do traders you know do this?
No!
90% of traders do not know about positive expectancy. They are too focused on technical analysis, win rate, etc.
If you know your win rate, risk-reward ratio, and expectancy, you are ahead of 90% of traders out there.
So if you are not tracking your every trade, maybe you should start now.
Because you can not apply it if you do not track all your trades.
I understand he is lazy to do, because it requires mathematics. I know that, I also don't like math. But I know how important it is to trade.
I read several articles and do some research about positive expectancy and risk-reward ratio, so that I can explain it better to you. Hope you learned something new here, and good luck to your trading journey.