Reward/risk has to be right

Slightly embarrassingly on my part, I discovered something simple but fundamentally wrong with my trading. I adjusted today and amended my ‘how to trade’ page. Even a tweak, if it is a significant tweak, can make a profound difference.

As in many things, but I feel particularly in trading, I cannot be so keen on my backtest work that I’m not prepared to take a fresh look once I’m in the trading room for real. As Yogi Berra said, “in theory, there is no difference between theory and practise; in practice there is.”

My foundation is my reward/risk, or what is referred to as R. To achieve a planned 2R (actual R can be much better) means that my planned reward is twice my planned risk. I had the minimum acceptable R as too small. Again, in theory (or backtest) it’s okay but in practice – often with a less precise entry point and a variable spread – working with less than 1R is not viable for me.

I call a 1R a scalp and a 2R a swing. My strategy, because of my abundance of less than 1R scalp opportunities, was scalp/swing. And this provided me with few swings. Moreover, the scalp element (less than 1R) required an 80% (win/loss) success rate to see an accumulation of reward.

Changing to swing/scalp and limiting scalp to not less than 1R is much preferable. Profitable scalp percentage is now 60% – still high but that’s the issue with scalping. And the swing percentage to be useful is 40%; anyone suggesting less does not have a spread to contend with (prop trader rather than retail trader), or they’ve ignored it.

To a non-trader, this all seems a lot about nothing. But it’s like a golfer playing a match without the long clubs and therefore having to take too many hits on the par five holes.

Leave a Reply