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

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Inspiritsa

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.
 
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.
 
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:
 
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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.
 
DevBru said:
The best way to calculate the best risk to reward for your system is backtesting.
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That is always the correct answer.

The ratio stop-loss/target must be determined by the trading rules of the system and the backtest.
 
Inspiritsa said:
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.
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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).
 
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Tradex said:
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).
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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.
 
Inspiritsa said:
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.
More...
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.
 
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