Quote from joe4422:
Now look at option 2. 13 point stop, 4 point reward. This is why you've spent the last 3 months losing money.
I think I have answered your concern about risk/reward several times before but I elaborate it here again.
When you are looking at stop and target, you have to take into consideration their corresponding probability as well.
Let's assume we do not know anything about a trade and we pick a random entry point. Then we pick a 4 point target and 13 point stop. The probability of reaching target is 13/(13 + 4) = 13/17 = 76.5%
The probability of reaching stop is 4/17 = 23.5%.
why? because out of every 17 times we get 4 losses of 13 points and 13 losses of 4 points. 4 * 13 = 13 * 4.
This is an even trade before commission and slippage. You can change those numbers from 13 and 4 to any other number and you still get an even trade. You will not lower or increase your odds of winning buy increasing your target or decreasing your stop. Your profit expectancy remains the same regardless of you target/stop ratio.
This was about random entry. In the case of signal # 2, I have calculated the probability to be about 91%.
So out of every 100 times we expect
91 wins of 4 points = 364
8 losses of 13 points = 104 => net profit of 260 points or average 2.6 points per trade.
I hope this is helpful for you to understand the concept of profit expectancy as opposed to risk/reward ratio.
