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Equity Management Money Managment Risk Reward

Discussion in 'Beginners Bootcamp' started by Agent86, Apr 5, 2010.

  1. Agent86

    Agent86 Sergeant

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    Hi all

    Bored so I'll post something for new traders

    I feel this is the most important subject to new traders.
    Equity Management Money Management Risk Reward are some terms used.

    Consider this:
    Assuming you understand what a stop and target is; and what a risk/reward ratio is.

    If you risk lets say 1:2 or some refer to it as 2:1
    I still don't know which is proper, but anyhow lets use 1:2 risk/reward ratio

    Consider you place a trade with a 1:2 ratio
    Lets say on a 5min chart you see a trades that could produce a potential trade of 10pips/20pips which means you will risk 10 pips to get 20 pips or more

    Anyhow, in this example lets say you traded a mini lot which has a pip value of $1 per pip.

    In this case 1 mini lot would produce a risk of $10/$20 in our example

    Consider if you lose 5 times and win 5 times
    You would have lost $25, but won $50 and ended with a $25 profit
    In other words you lost 5 times worth $5 for a total of 25$
    Won 5 times worth $50
    Total profit of $25 after being wrong 50% of the time

    So in this scenario you would have been wrong a lot

    If you trade lets say .2 lots or micro lots which hold a pip value of $1 per pip.
    You might have gained $50 instead of $25 on only a 50% probability

    Anyhow if you develop even a strategy that is right only 50% of the time or even slightly less you can still produce a profit when using a good risk/reward ratio

    Now all you have to do is work on your strategy or use someone elses and incorporate the probability into what you think is a safe risk/reward for you.

    Some trade even 1:3 or even 1:4 which could be less probably however, might produce more pips and actually have a lower probability of winning could even be as low as only 20% right and still end up in nice profits.

    Anyhow thats just one way of looking at Managing your trades.

    Happy trading.
     
    #1 Agent86, Apr 5, 2010
    Last edited: Apr 5, 2010
  2. Pharaoh

    Pharaoh Colonel

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    Excellent post and well worth remembering.

    Watch out for services that claim 90+% winning trades. Most of these do it by having terrible risk-reward ratios. It doesn't do you any good to profit 90% of the time if those 10% losses are huge compared to the gains.

    Example - An ea that closes at 5 pips profit, but has a 500 pip stoploss. Unless it consistently wins more than 99% of the time, it will lose in the long run.
     
  3. Agent86

    Agent86 Sergeant

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    RE: Equity Management

    Thanks, I'm glad you like it.

    I figured beginners need all the help they can get and this might be the best place to start even before strategy.

    Anyhow, happy chatting.
     
  4. clinger

    clinger Recruit

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    I think this is where I'm going wrong, In the last 2 months I have earnt over 2500 pips but have actually lost money over this period. I am obviously not looking at risk and reward correctly. Happy to receive any pointers.
     
  5. Agent86

    Agent86 Sergeant

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    Risk Reward is not always always a good rule, but depends

    Risk Reward is not always always a good rule, but depends on the strategy.

    Some that use indicators may not use the risk/reward ratio topics.
    But instead put in a sort of max stop/loss that they are willing to lose if the market gets a huge spike that is not normal.
    People who use mostly indicators may not set a risk/reward rule because their target might be a indicator reversal and their risk might be a indicator reversal as well.
    In this case they may follow a different risk/reward structure that may not actually be strictly defined.
    But it's good to at least set a min. stop/loss rule to protect your equity.

    However for the less mechanical trading strategies I tend to lean toward a strict risk/reward ratio but also as I mentioned in this post it can increase your chances of making pips.

    There is an equilibrium that needs to be worked out vs the percent of your trades that are gains vs the percent of your trades that are losses.
    Just remember this word TRADING EQUILIBRIUM. I just made this up, but

    Lets say your trading a standard account with lot sizes of 100k and cost you a 1000 USD to open a position, just for example

    OK so you open a position and you want to risk lets say 10 pips in which each pip is worth $10 ($10x10pip = $100 risk)
    If you had a 2:1 risk/reward then you would risk $100 to gain $200 elementary right ?

    Here is where the TRADING EQUILIBRIUM topic comes in.
    So lets say your testing strategies and you have one that backtests at 50%wins vs 50
    % loses
    5 trades go against you $100x5trades = -$500
    5 trades go in your favor $200x5 = $1000
    net profit on 10 trades = $500 not too bad really for 50/50

    So is 50/50 better then or 30/70 win/loss?
    Lets say you have a strategy that is 70% lossers and only 30% winners
    At first glance you would think this is NO GOOD right ?

    But depending on your risk/reward lets say you kept your strategy the exact same but instead all you did to lower your ratio to get a 30/70 was to change your risk/reward from 2:1 to 4:1

    Consider this the equilibrium which is the difference in profit when you apply a lower risk/reward to a higher risk reward. And at what point is having a lower win/loss ratio actually better and means more pips per month.

    Lets continue with the example:
    So now your trading the same strategy that was paying 50/50 with 2:1 but now your only getting 30/70 with 4:1

    10pip/40pip = $100/$400 risk reward.

    So in this example you win 30% of the time and loss 70% of the time
    Lets LOOK:
    3 trades in your favor = $400x3 = $1200
    7 trades against = $100x7=$700
    net profit of only $500
    so this would actually be exactly the same as the other strategy.

    However, over time and longer periods lets say over a 1 years period this strategy could produce slightly higher ratio of perhaps 35/65 or even 40/60 win/loos in which case it would be much higher profit levels per month then the 50/50.
    Lets LOOK
    $400x3.5=$1400
    $100x6.5=$650
    net profit of $750, this is much better profits then the 50/50 ratio but with less accuracy too.

    Lets LOOK at the 40/60
    $400x4 = $1600
    $100x6 = -600
    net profit of $100 on a 40/60 with 4:1 and the profit is almost doubled yet the win/loss ratio is worse.

    And this is the delicate example of how the risk/reward vs the win/loss ratio can be considered a sort of TRADING EQUILIBRIUM.

    I have tested simple single indicator trading system that use a 4:1 risk/reward and is only 30% accurate thats 30/70 wins/losses and when back tested it produces 300 pips per month regularly ;and largest drawdown is 110pips
    Not really a great strategy but I like back testing these scenarios and reviewing them.
    What this means is that you can risk only 10 pips and loss a max drawdown of 11 trades against you for a total of 110 pips and continue to enjoy a gain of 300 pips per month in spite of being a real big loser LOL.

    There is probably a real term for this topic already other then TRADING EQUILIBRIUM, but I'm not sure what one would call it.

    Anyhow,Sorry for the long winded response
    Happy Trading.
     
    #5 Agent86, Jun 28, 2010
    Last edited: Jun 28, 2010
  6. Pharaoh

    Pharaoh Colonel

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    I call it "Did I make money or did I lose money?". :D
     
  7. Agent86

    Agent86 Sergeant

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    Make money or lose money

    Yep

    How about MO MONEY LOL

    How to make MO money without usin YO money

    No but seriously there are times when you can make more money with worse odds depending on the risk/reward ratio you use for your strategy, but that is something a person has to consider if they can't figure out a better startegy then an already working strategy.

    There is a sweet spot in which you can end up making more profit with lower win/loss ratio.

    Exactly what that sweet spot is depends on the strategy and the current working win/loss ratio.

    Perhaps G SPOT could be the trading term.

    I could write a book on how to find the G spot in forex LOL.

    Happy trading
     
  8. seethestars

    seethestars Private

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    Money Management

    Hi To All.
    I am very new to trading and am finding the advice and knowledge on this site invaluable. As a newbie and totally pants at math I wonder if you could help me.
    If I start with a 'bank' of 3000 and trade at 3per pip and make 5pips per day,
    does anyone know what the 'exponential growth' would be after 3years?
    Thanx again and kind regards.
     
  9. Agent86

    Agent86 Sergeant

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    3per pip ?

    What do you mean 3 per pips ?
    $3 per pip ?

    And also do you plan to expand those lots as growth occurs or just leave it at the same amount traded every time ?

    $10,800 would be the case if you estimate 5pips per day @$3 per pip = $15 per day x typically only 20 trading days per month approx.

    So $15 x 20 = $300 per month x 12 months = $3600 per year which is approx 120% ROI per year

    $3600 x 3 years = $10,800

    However if you increased / compounded your investment every 3 months by adding a .1 fractional lot or even .2 fractional lots every 300 pips, then you could exponentially increase to well over 30k approx.

    However, you would need a strategy of cutting lots for every 25-50 pips in losses as well, otherwise you would loss the pips you created during that time as well.

    However the compounding topic requires some understanding about the strategy , and the backtested or forward tested maximum drawdowns etc.

    Anyhow Hope this helps.
    Happy trading.
     
  10. seethestars

    seethestars Private

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    Hello Agent86, and many thanx for your post.
    I hope to raise £3000 and will use £3 per pip and aim to hit at least 25pips per week. I increase/decrease % at the end of every trade day.
    Thanx again.
     

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