Are you tired of losing trade after trade? Are you struggling to win a few trades and then turn around and give it all back after one or two losing trades?
One of the most important traits successful traders possess is knowing how to day trade using a proper reward to risk ratio. If you can relate to the trader who is always taking one step forward and two steps back, don’t get discouraged. Stick with me until the end.
If you are anything like me when I was trying to break into the world of trading, both your nightstand and office desk are stacked high with books laying out the blueprint for becoming a successful trader. While I was expecting to read all about win/loss ratio, the number of pages dedicated to money management, risk to reward ratio, and position sizing were surprising to me. But as I sit here today, several years later with thousands of trades completed, I can honestly say, I get it. It makes perfect sense why so many chose to take up so much time explaining these three topics.
This week’s video will allow you to see what I am looking for in my trades and hear why I made the decisions that I have made. I will explain why I focus on the process of the trade instead of the actual outcome of the trade.
I will also discuss how I structure my trades with a positive reward to risk ratio. Yes, it’s true, by having a positive reward to risk ratio I do decrease my win/loss ratio, but does a win/loss ratio pay the bills? No, but using a proper risk to reward ratio can increase your odds of having a positive profit and loss (P&L).
To explain this a little further let’s discuss an example using Trader A and Trader B.
Trader A has a 60% win/loss ratio and negative reward to risk ratio. Trader A’s reward to risk ratio is considered negative because even when he wins a trade, and he makes a $1 when he loses a trade, he loses $2. If Trader A placed 100 trades, he would make $60 because he won 60 trades out of the 100 trades placed. He would also lose $80 because he would lose 40 of the trades placed that cost him $2 a trade. So we can say his net P&L would be -$20.
Trader B only has a 50% win/loss ratio but has a positive reward to risk ratio. Even though Trader B loses $1 when he loses a trade, he makes $2 when he wins a trade, therefore making his reward to risk ratio positive. If Trader B placed 100 trades and had 50 winning trades at a profit of $2 a trade, he would make $100. Trader B would also lose $50 because of losing his 50 remaining trades at $1 a trade. So we can say his net P&L would be $50.
Who would you rather be, Trader A or Trader B?