Return on Risk factors when trading Forex Market Behavior

 

Return on Risk

Return on risk then trading Forex Market Behavior refers to the return a trader gets on the risk exposed to. The risk is normally referred to as the dollar amount the trader will lose it stopped out. The return is the dollar amount gained when the deal is closed.

Some traders use the pips size of the stop and the pip size of the target. This is however not that accurate as the spread needs to be added to the stop and to be subtracted from the target to be correct.

The most meaningful way of measuring this is, however , to take the average dollar loss to represent the risk and the average dollar gain to represent the reward for 10 to 20 actual forex trades.

Success Rate

The return on risk performance is however not one that you should look at on its own.  You HAVE TO take success rate into account. Success rate refers to the number of successful trades compared to the total trades taken.

So if the trader had 30 successful trades out of 50 the success rate would be 60% which sounds good.  However if the average reward on risk is $30 to $50 then this trader is in fact making a loss. ($30 x 60%) + (-$50 x 40%) = +$18 – $20 = -$2 per trade.

If the average reward on risk is however reversed at $50 for successful trades and $30 for unsuccessful trades the result is quite different. ($50 x 60%) + (-$30 x40%) = $30 – $12 = +$18 per trade.

So the message is

  1. You cannot look at either the success rate or the Return on Risk ratio on their own.
  2. You HAVE TO look at both at the same time.
  3. If you get both right you are onto a massive winning formula
  4. It is possible to be profitable even if one leg is not ideal

Stop sizes

Another factor to bear in mind is that in general the bigger your stop the higher your chances of success. That means that the stop should be a reasonable size to give your deal a chance of success.

So the key factors that determine your trading success is the balance between:-

  • Your success rate – ideally you want this to be high
  • Return on risk – ideally you want this to be positive
  • Size of stops used – ideally you want them to be big

Select settings for your strategy

So why are we talking about all of these factors. When we come to testing the market behaviour  systems you find a huge number of successful combinations of settings  that are profitable and which you can use. You will need to select ones that give you best balance of the above.

 

 

3 Comments

  • Mick

    Reply Reply July 2, 2015

    I agree with your concept but have 1 more criteria to add – logic.
    Often missed by some traders. What I mean is the results not only have to make money but the answers have to be logical.

    If optimised passes of the EA indicate that the previous trend needs to 40-60 in length then I consider that logical. If, on the other hand, the best profitable combinations are using a previous trend with 10-20 pips then I would say that is illogical.

    All that is doing is finding a “nice” solution to give a high return. It is just curve-fitting or over-optimizing.

    • Alex du Plooy

      Reply Reply July 2, 2015

      There are a few things I have learnt about the Market. It is like a lady. You need to trade it the way it wants to be traded (Like a lady it gives you lots of clues) and you must never impose your ego or mind onto it (Like a lady it is not logical or a overly confident forceful approach)

      So like trying to woo a lady, curve fitting is learning what the market likes, and like a lady trying to apply your ego and lawyer like logic to get your way will not get you onto 2nd base.

      The Market is sometimes more complicated than ego and logical thinkers think – it is best to make friends and find out what the lady likes.

      Just like a lady you will only know what works when it works in the future. Don’t expect it to work again the next night. Ladies are funny that way – They defy logic.

      Just my humble experience.

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