Does it ever make sense to have a risk-to-reward ratio of 2:1?
- Thread starter nwoptions
- Start date
Like I said (prior post), 1/2 not 2/1 but get your point.
By the way, the well-known CANSLIM system is not that profitable, according to some studies, take a look at this one for instance :
https://www.cbsnews.com/news/dont-confuse-strategy-with-outcome/
I do like and respect its creator however (William O'Neil), and enjoy reading his Investor's Business Daily newspaper.
How long you plan on holding? That’s a critical component of the stop placement. In your case, I assume you use the IBD method for long only stock positions near a new high. So upon entry something simple like this would be a good starting point:
1 week hold- ATR(30) * .50 Stop
2 week hold- ATR(30) * 1.0 Stop
3 week———-ATR(30) * 1.5 Stop
4 week———-ATR(30) * 2.0 Stop
and so on.........
You can adjust/trail the stop by same amount for each given timeframe. Targets should be at least 4x your risk. I personally don’t use targets. There is something really demoralizing (for me at least) about taking smaller profits, while the market continues strongly in the intended direction. I let the market take me out.
Exactly, we’re talking outrights here. In regards to option premium selling, these inverse ratios may work, but it’s way outside of my scope.
IMO, Risk Reward calculations come AFTER, the details of the trade: Probability of a win, Support-Resistance levels relative to being above-below, the stops and targets. Some people look for it as an input filter on which trades to take, up to a point.
It is also good as an AFTER the trade metric, BTW.
It is also good as an AFTER the trade metric, BTW.
A risk-to-reward ratio in isolation is irrelevant. If it weren't, the best bet would be playing the lottery.
What makes more sense is profit factor = (average win * win percentage) / (average loss * loss percentage). An equivalent formula for profit factor is gross profit / gross loss.
Imagine a PF of 2.0 which is really good. You can achieve it with:
1. $300 avg win, $100 avg loss, 40% winners
2. $200 avg win, $100 avg loss, 50% winners
3. $100 avg win, $200 avg loss, 80% winners
On this information, all three strategies are equally good. To discern more, additional metrics like Sharpe/Sortino are needed.
Some intuition for profit factor:
- a PF of 1.0 is break-even
- a PF of X means that on average, you make X dollars for every $1 you lose
What makes more sense is profit factor = (average win * win percentage) / (average loss * loss percentage). An equivalent formula for profit factor is gross profit / gross loss.
Imagine a PF of 2.0 which is really good. You can achieve it with:
1. $300 avg win, $100 avg loss, 40% winners
2. $200 avg win, $100 avg loss, 50% winners
3. $100 avg win, $200 avg loss, 80% winners
On this information, all three strategies are equally good. To discern more, additional metrics like Sharpe/Sortino are needed.
Some intuition for profit factor:
- a PF of 1.0 is break-even
- a PF of X means that on average, you make X dollars for every $1 you lose
Eckhardt was trading decades ago. Things are completely different now, so what he tells has no value anymore today.
Success rate of trades is part of the formula to calculate expectancy. So surely not the least important performance statistic.