Forex Strategies and Tips
Risk-To-Reward Is Meaningless
At least... as most traders think about it. Because most traders, forums and courses all refer to risk-to-reward as a measure of your trades' worth in and of itself... and by itself like that, it is meaningless.
This drives us nuts!
Risk to Reward is NOT the gold standard for a good trade that it is made out to be.
The truth is: if you only look at risk-to-reward and do not look at your win to loss ratio (how many times you win on average) then you don't know anything about your trading.
Risk-To-Reward + PLUS + Win-To-Loss
If you look at both these ways of measuring your trading results together – at the same time – then you're looking at your trading with a sharp and keen eye like a professional.
Here's an example: We know traders with a strategy like this:
They have a set take-profit of 7 pips and a stop-loss of 11 pips.
We've heard them get criticized for having a bad risk-to-reward. It's not even 1:1. But guess what?
If they win more than 64% of the time with this scenario - they are really profitable with this so-called "bad risk-to-reward".
Here's another example: We know traders with a strategy that uses:
A take-profit of 50 pips and a stop-loss of 25 pips.
Great risk-to-reward, right? 2:1. But as careful as they are to trade well, they only have a win-to-loss ratio of 29%. So even with this great R:R they are not profitable.
How To Find Your Win-To-Loss %
Win to loss ratio is the measurement of:
how many wins you have ÷ how many total trades you took
You can manually go through all your trades and count how many won and how many lost. Add them together to get the total number, then do the division. Or if you have the Forex Smart Tools Trade Log it does this work for you. On the Summary tab of the Trade Log you can immediately see this information:
In the Trade Log, you can see this information for any one broker at a time, multiple brokers grouped together – or if you trade multiple strategies, you can see this information for any one particular strategy.
About The Risk-To Return %
You will often see Risk To Return abbreviated as R:R.
If your stop is the same as your take profit, you have a R:R of 1:1 (or 100%).
If you try for twice the profit of the size of your stop your R:R is 1:2 (or 200%).
If you always use the same stop loss and always use the same take profit, you already have the correct values to use in your analysis.
But if you use different stops for each trade, change your stop as a trade develops or take different profits based on the technical setup of each trade – then you need to separate out your wins and losses before you know your own true values to use.
This is where skill with a spreadsheet comes into play – or owning the Trade Log.
Using The Trade Log To Find Actual R:R
The Trade Log will group all your wins and losses together, showing you aggregate results for them all together. So the first task will be to separate each group out into its own report, so you can look at wins independently from losses.
Step One: Create a New Report (Analysis Preset) For Wins
In the analysis tab of the Trade Log, click New next to Preset and pick whichever broker you want to analyze, or you may choose all your brokers or a specific group of brokers.
Create a filter for working pips > 0 to see your winners.
Or you might think of trades that have a little loss or gain as essentially being 'break even' trades you don't really count, so you could set it for trades greater than that amount. For instance, we might think of a win of 2 pips as break even, so we could just count trades that win more than that as a win. Here's what that looks like in your report filter in the Trade Log:
This will create a report of just your wins. Then you can scroll to the bottom of the report to see your average take profit.
Here's an example of a trader with an average take profit of 15:
Step Two: Create a New Report (Analysis Preset) For Losses
In the same way, you will create a separate preset for your losses. Create a filter for working pips < 0 or less than whatever you think of a 'break-even'.
Save this report then scroll down to the bottom to see your average for your losses.
Now You're Ready For In-Depth Analysis
So what's the best way to look at your trading to know how strong or robust it is? Whether it will make you money in the long haul?
The ideal is to use both the Trade Log and the spreadsheet we provide in combination. Each tool provides you with information that the other doesn't.
Yes, the Trade Log will quickly tell you the truth about trades that you've actually taken.
But is that everything you need to know? No, because if you applied your same trading strategy at a different time of year or in another year, you might get very different results.
Here are three ways how to improve your analysis:
- Trade a lot longer so you have a larger pool of data to look at;
- Use the Forex Tester to speed up getting more trades to look at;
- Use our spreadsheet to take your specific numbers and generalize them over hundreds of trades.
We like options 2 or 3 the best. Personally, we don't want to spend a lot of time trading a strategy that may not be worthwhile in the long run. We want to find out about our trading as directly and quickly as we can.
Combining what you learn from your trade in the Trade Log with the spreadsheet will tell you about your profit potential with your take profit and stop loss and win ratio over many thousands of trades in a few minutes.
Our spreadsheet is great, but the generalized information of the spreadsheet is not enough by itself, because you need to see if you are actually pulling in those numbers in real life - and that's why you also need to use the Trade Log too.