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#245: The Importance of High Reward:Risk

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The Importance of High Reward:Risk

In this weekly video:
00:32 – Understanding high reward:risk trades
00:55 – Letting losing trades to get even bigger
02:00 – Reward:Risk of 3:1 – what does that mean?
02:58 – Is a 90% win rate a good system?
04:00 – Growing your account
05:10 – Further trading help for you

I'm going to explain how understanding the reward to risk ratio of your trades can dramatically change around your trading results. Let's get into that and more right now.

Hi, Forex traders. Andrew Mitchem here. The Forex Trading Coach, video and podcast number 245. I‘m gonna talk about a very, very important subject. It's all about understanding how important it is to have correct reward to risk. High reward to risk trades. It is something as simple as this can dramatically change around your trading results.

Understanding High Reward:Risk Trades

If you do not have high reward to risk trades, the probability is you'll be losing money. Let's talk about that.

When you think about the psychology behind trading, why is it that so many traders, when they have losing trades, they're happy to let those losing trades get bigger and from time to time.

Letting losing trades to get even bigger

People will move the losses further away even and allow that stock loss or that trade, that's losing, to become even bigger loss. You flip it round the other way and why is it that so many times, when traders are in a profit, just a small profit, they want to start fiddling with the trade, they want to start closing the trade, partial closing, closing all of it, locking in profits, et cetera. It just doesn't add up.

When you have a trade that's losing, people are happy to let it lose and let the loss get bigger. When it trades the right way and you're picking the market the right direction, everybody wants to click their mouse and close their trades early. When, in reality, you should actually let that trade get to its full profit target because you picked a good trade. It's a very odd, but very common problem. Think of things this way, always understand reward to risk. Most people actually say risk to reward, whereas you notice I'm saying reward to risk.

Reward:Risk of 3:1 – what does that mean?

Let's say for the ease of numbers, that our trades have a three to one reward to risk ration. What does that mean? It means, let's say the trade is risking $100 but it's making three times that if it gets to its profit target. It's making $300. Think of it this way as well, let's say I have two losing trades and one winning trade. I'm still profitable. I have a 33% success rate, which you would say, “Andrew, that's terrible.” But think of it this way, I'm losing two trades at $100 so a total of $200 lost but my next trade hits the full profit target for a $300 gain. Net result, I'm $100 up.

Also, if someone says to you, “I have a 90% win rate,” it doesn't mean to say they're making money. You see, if you're taking lots of small gains or break even trades, tiny gains.

Is a 90% win rate a good system?

We have one or two big losses, then those losses completely outdo all those small gains you've got. The win rate really is not that important. What is important is having high reward to risk trades.

For me, as a trader who prefers the higher timeframe charts, the higher timeframe charts and I mean something like over a one hour chart, four hour chart. If you've got non-standard MT4 charts like I can when I'm trading six, eight and 12 hourly charts, or daily charts or weekly charts or monthly charts, generally the higher the timeframe the trade that you're taking, generally the higher reward to risk of that trade can be. Spread becomes less of an issue and various other things that you generally get somewhere between a two to even a five to one reward to risk ration across those trades. If you do that, you can see how by understanding probability, by understanding reward to risk ratios, how you can substantially grow your account.

Growing your account

It's really important that you understand this. There is no point in having lots of small gains and big losses, just no point at all. Remember, when you pick a trade in the right direction and you see it heading in your direction, let the trade get to your profit target. Have high reward to risk trades. Try and aim somewhere between a two and a four, or even a five to one, depending on the setup of course. It's really important you don't just randomly pick a figure and say, “All my trades are gonna be three to one” because that's not gonna work either. You have to have a system in place that allows you to do that and you have to have the specific individual trade set up with a stop loss of profit target that allows you to do that. Just assume for the sake and ease of numbers that all your trades are a three to one reward to risk. Two trades wrong, one trade right, still making money. It's an important part of trading that you must understand and get right and get in your favour.

Further trading help for you

If you'd like any help with that, just contact me, [email protected] Have a look through my website and there's lots of information there that can help you. I hope that was useful. I'll see you this time next week.

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  • jiggerdigger

    Hi Andrew. I always find your videos/articles interesting, none more so than this latest one on Reward:Risk (R:R), which has always been a bit of a bone of contention with me. I have long held the view (and still do) that the R:R concept is partly an invention of market makers, brokers and so forth, specifically designed to relieve inexperienced retail traders of their hard-earned cash. I could probably write a book on the subject, but won’t bore you with my views of the minutiae associated with R:R. What I will say, however, is that in my opinion, the application of the received ‘wisdom’ of R:R by inexperienced traders is likely to ‘kill’ them almost as quickly as placing their stops too tightly (a common ailment with some association with the R:R concept, I think. Perhaps you could do a podcast at some point on that particular danger?). Frankly, they’d be better having no stops at all; that way, at least the pain would be over and done with relatively quickly, rather than the ‘death by a thousand cuts’ which many suffer! (I know, I’ve been there!). I note from the podcast that you included a caveat which I think, in some respects at least, ‘kind of’ agrees with what I am saying. Conversely, I suppose I am. in a way, suggesting to the aforementioned traders that it might be a good idea to take your course! Without trading knowledge, backed up by a tried and tested strategy/ies (your caveat), R:R is best left alone; but then to be blunt, trading would be best left alone in those circumstances! Anyway, thanks again for your insights which are always useful; and yes, I do assess my risk before taking a trade!

    • Andrew Mitchem

      Hi, Reward:Risk is very important as is using a stop loss. Without a stop loss you can not assess your position size needed for each trade. They all work together. I try to get traders away from using a stop loss at 10 pips or 20 pips ….. as those levels are meaningless. The stop loss needs to be at a certain level for a reason and as a technical trader, I use a technical reason for the stop loss. It is never a fixed pip size. I also never aim to make a certain amount of pips. I’ve been trading since 2003 and I would have zero idea how many pips I’ve made as I’ve never counted them. Due to the way I trade and teach, reward;risk levels are always high – hence I may have a lower win rate than some people but the percentage gain made is higher – and afterall, we’re in this market to make money – not pips!