Balance Risk vs Reward and Win/Loss Ratio

The reason that new traders blow out their accounts on an average of 4 months as they assume trading is easy, they don’t realize the role their emotions play in trading with real money. MJFX Forex believes it is extremely important to identify entry, stop, and profit target(s) before entering every trade.

Second question is good Risk Reward Ratio or Win/Loss Ration more important? Winning percentages are important, but stand a distant second to risk/reward in terms of order of importance. Although traders would love to boast a high winning percentage, we would rather maintain a consistent and profitable track record. Assuming that we, as traders, will consistently beat the market (in other words, maintain a high win ratio) is a rather tricky mindset to have…especially when trading off a purely technical standpoint as is the case with these technical analysis recommendations. That’s not to say that there are not strategies/traders that have high win ratios, but they typically carry much greater losses in terms of percentages (i.e. risk vs. reward).

For a vast majority of traders—both newbie’s and veterans alike (e.g. the infamous turtle traders)—focusing on win ratios is a path that most oftentimes leads to a gut-wrenching downward spiral. A trader/strategy with an 80% win ratio may have a similar (or even worse) percentage return over time compared to a trader/strategy with just a 30% win ratio, for example. The reason behind this, generally speaking, is that winning a high percentage of trades is typically the result of a bunch of small wins with the occasional big loser. There’s nothing wrong with that as long as numbers work out and profitability is sustained over time. Unfortunately, this most oftentimes is not the case and just a few losing trades in a row within this type of model could easily wipe out an account, or at least make life a little more emotional (a.k.a. miserable) than it ever ought to be (which typically results in further losses since Money+Emotion=Disaster, thus the downward spiral).

Conversely, focusing on risk/reward allows for a more mechanical style of placing trades which significantly helps curb the emotional aspect of trading, which is paramount. This also allows for the age-old “cut losses quickly, and let profits run” mentality vs. the high win ratio mentality which tends to be more of a “take your profits quickly, and let your losses run.” mindset. The way we look at it…it’s way easier (and less suicidal) to take what the market gives you focusing on risk/reward and sustained profitability (where constant vigilance in terms of risk/money management is essential so that each trade no matter of how many pips of risk there may be always represents a percentage of total equity–usually between 2-5%) as opposed to trying to find the “holy grail” technical strategy, or that magic little pill which does little more than feed the ego.

We feel it is important to know your risk:reward ratio before entering a trade. How on earth can you determine your risk reward:ratio if you don’t plan your stop and profit target(s) before entering the trade? It can’t be done. To measure this ratio, simply divide the distance between the entry and the profit target by the distance between the entry and the stop. Everyone’s concept of a “good” risk:reward ratio varies, but we prefer to have a risk:reward ratio around 1:1.5.

The key here is BALANCE. Our research shows that Aug 08 – Jan 09 Trending Market, Good Risk/Reward Ratio Traders performed better while Feb 09 – July 09 Ranging Market, Good Win/Loss Ratio Traders have their upper hands. To balance these two animals, MJFX Forex uses Sun Tze Money Management (T/M) and we are always ONE STEP AHEAD.

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