Avoiding this disaster is, luckily, easier than you think. Besides the win rate, we always focus on a simple formula called the “reward to risk ratio”. Simply said, it means that you compare two figures with each other: what do you win when you win and how much do you lose when you lose.
This article not only explains the reward to risk ratio itself but also shows how the reward to risk ratio offers more transparency and why this is one of our core principles at Elite CurrenSea. But first, we start with the importance of good Forex education.
Forex Education – Be Aware
The continuous supply of online trading education seems endless. The volume of material could easily overwhelm anyone who is looking to start with trading or anyone who is searching for more in-depth information about trading.
Often trading educators promote oversimplified information in an attempt to impress their public… But they purposefully ignore or fail to share their full trade statistics.
Luckily, there are a couple of key tips and tricks that traders can use in order to find good and reliable mentors. Following these few critical steps could save you a lot of headaches:
- Research the mentoring website on Forex Peace Army. Evaluate the rating, check the comments and also make sure that there are a sufficient number of reviews.
- Evaluate their transparency and openness. Evaluate whether they are sharing their trading statistics and also check what information is being shared.
- Check out their YouTube channel. Are there serious videos with good analysis and education or are they only promoting others and offering quick-rich schemes?
- Check their website for day-to-day help. Anyone can create a system and leave it there forever. Live analysis and setups indicate an active team.
- Visit their seminars. Speaking to traders face-to-face makes a huge difference and you can judge their word and credibility easier.
When you keep an eye on these 5 things, then you know that you are talking to serious traders with meaningful and professional advice.
Especially seminars offer a useful way of learning. First of all, the information is conveyed face-to-face which makes it easier to retain knowledge. Secondly, seminars add a networking opportunity to the mix as well.
Talking to other traders from the trading community can be almost as valuable as learning from mentors themselves. Traders like to help each other out by sharing tips, explaining tricks, and showing new short-cuts. Generally speaking, traders can learn a lot from their mentors, peers, and even students (teaching traders with less experience). Good mentors strive to offer a hub where trader learn, network, connect, become curious, and get creative.
The first concept that we explain to traders when they join our seminars or website is this simple fact: the reward to risk ratio is just as important as the win percentage. Most traders are surprised or even shocked, to hear this statement but the mathematical truth is simple. Let’s explain.
A danger of Only Using Win Rate
Do you sometimes dream of achieving a 99% win rate? It seems perfect but only a few traders understand the underlying risk. Essentially one bad loss or unlikely event could make your track record meaningless. Sometimes traders call this unlikely event a Black Swan (a low chance event with a massive impact – any regular loss in Forex and CFD trading is not considered a Black Swan).
Let’s say that you managed to trade with unprecedented accuracy and you made:
- 25 wins in a row
- With an average of 2 pips per trade
- For a total of 50 pips.
Of course, nobody can book wins forever and a loss is only a question of time. Ironically, it only takes one loss of 50 pips to wipe out all of the previous gains. A loss of 100 pips in one single trade setup, in fact, puts the entire account at a major loss (+50 – 100 = -50 pips).
Most traders like to aim for and boast about a high win rate but unfortunately, it just gives traders a false sense of achievement and security. A trader could actually win 95%+ of their trade setups but still lose money in the long run.
Reward to Risk Ratio Explained
Traders can improve their approach and trading performance by simply adding the reward to risk (R:R) ratio, besides using the win rate.
The R:R ratio indicates what traders can expect to win and loss on average. As mentioned above, what do traders win when they win and how much do they lose when they lose.
Here is a definition:
- Reward: average profit made per setup
- Risk: average loss made per setup
- Reward to risk ratio: average profit versus average loss.
Let’s give a simple example:
- Your winners closed for an average of 15 pips and your losses for an average of 10 pips – what is the R:R ratio?
- The answer is 1.5. The 15 pip average win is one and half time as a large as the 10 pip average loss.
Assuming an average win of 60% versus a loss percentage of 40, what is your expected profit?
- Expected profit = (average profit * win percent) – (average loss * loss percent)
- Let’s continue with our example:
(15 pips * 60%) – (10 pips * 40%) = (9 pips) – (4 pips) = +5 pips per setup.
All in all, you are netting an average of +5 pips per trade setup, even though your win rate is only 60%. Now compare the +5 pips expected profit with the ultra high win rate (25 wins out of 26 setups):
- (2 pips * 96%) – (50 pips * 4%) = (1.92 pips) – (2 pips) = -0.08 pips per setup.
The strategy with a 60%, counter-intuitive to many traders, is in fact far more profitable than a strategy that offers a 96% win rate. The R:R ratio helps you discover which strategy is better and more profitable and provides you with a 360-degree view of your average expected profits per setup.
There are two ways how you could improve your profit expectancy:
- Improve your win percentage by creating better trade ideas and/or improving your timing for trade entries.
- Improve your R:R ratio by cutting your losses short and/or letting your winners run.
The R:R ratio is a key aspect of risk management, which remains a core point for all type of traders.
Transparency and High Valued Education
We used the R:R ratio in this article as a prime example that trading is not as simple as some people promise. Many traders tend to boost their performance by only mentioning the pips gained (how risk is taken?) or their win rate (what is the R:R ratio?). Now you know that both of these statistics mean little without the proper context.
In fact, we at Elite CurrenSea decided to make its education more dynamic by offering regular forex and CFD seminars from the fall of 2018 and onwards. The first concept that we explain to traders when they join our seminars or website is this simple fact: the reward to risk ratio is just as important as the win percentage. If you find the topic interesting, join our facebook page and tune in to the live broadcast of the full Utrecht event 15:00 on February 16th. You can also find the recording later on our YouTube page.
Wishing you good trading,
Elite CurrenSea is a website focused on Forex & CFD trading, analysis, systems, and software. It offers two proprietary trading systems called ecs.CAMMACD and ecs.SWAT and also a live service with trade setups, ideas, analysis, and webinars called “ecs.LIVE”. Our trading is based on a mixture of indicators, patterns, and price action for tackling the markets.