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What is the best Risk Reward Ratio? But is that the right question?


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What is the best Risk Reward Ratio? But is that the right question?

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  #1 (permalink)
Tampa Florida
 
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This is the first thread that I am starting here on Future.io so before I get into it, I wanted to say thanks to Big Mike and the whole Futures.io community. I have soaked in a lot information from this great forum and I am grateful for all of you whom have shared your experiences so that we can keep learning.

Also, please keep in mind that this is my unorthodox approach to this risk reward topic. Use at your own risk. I just wanted to share how I personally devise a risk reward strategy before going live. This method works very well for me but may not work for you or your style of trading. There are many creative ways to look at things when devising a risk reward strategy and this is just another one of those.

The same question pops all the time: What is the best Risk Reward Ratio? But is that the right question?

At one time or another most traders will ask themselves that very same question. And honestly, it’s a tough one to answer considering all the different variables involved with trading. But there is (at least I feel) a way to answer this question, but from a different perspective. One that does not directly focus on the risk part at all, at first.

I trade the NQ and I do not use stop losses. However, I do have a 50-pt catastrophic stop loss, but I do not include it when building and back testing a strategy. More on that later.

One of my strategies is where I shoot for a 10-pt profit target. Back in the day, I also tried the 1:1, but it wasn't until I completely removed the common “risk reward" stop loss that I went to an 85%+ win rate on the strategy alone. I also managed to pick up another ±10% of profitability bumping it up to a ± 95% win rate, which I’ll also explain later.

So why no stop loss is better? For two reasons. Your trade needs breathing room, and you have to account for running of stops.

Let's hypothetically say that you have insider information telling you that the price is headed to an important price level. Well, even though you now know where it's going, I’m sure you can agree that it will not get there in a in a straight line. Instead, there will be many peaks and valleys along the way. Those peaks and valleys are designed to take your money while in transit to that important price level.

The key for me is having a fully back tested strategy that is proven successful during normal market conditions but without having any stop loss. That’s right, no conventional stop loss. With that said, a stop loss does needs to be part of your strategy, but it should not get in the way of making profit. Instead, it should help you when you truly need it.

Try this. Back test your strategy with no stop loss at all, and see if your trade would actually reach your profit target. Don't pay attention to the actual loss amount for now. If your trade wins vs losses percentage is bad, then your strategy was bad from the start and needs to be either optimized or scrapped all together. For me personally, if a new strategy that I created cannot get good back testing results without a stop loss, then I didn’t work hard enough on that strategy.

In trading, talk is cheap, so I wanted to share the 60-day back testing results on a strategy I created using 3 NQ contracts.



Strategy Performance report #1 shows my strategy results without any stop losses used. The Strategy Performance report #2 of the same strategy are the results of a 1:1 risk reward ratio. I know what you’re thinking; what about using a 1:2, or 1:3 ratio, or, 2:2, or 3:3 ratio? Been there done tested that, none of them work. At least not for this specific strategy.

Two points I want to cover from earlier. One is that 50-pt stop loss. When testing a strategy, I do not include it into the strategy building because it’s just like the 1:1, or 1:2, it doesn’t work and it would falsely skew my results into negative territory where I would believe that my strategy either sucks or just flat out doesn’t work. This is clearly demonstrated with Strategy Performance report #2 when using 1:1. The 50-pt stop is only there for catastrophic reasons during live trading.

Secondly, how do I squeeze another ±10% of profit and avoid those drawdowns? Looking at Strategy Performance report #1 (without stop loss), you will see the number of wins and losses. Well, there are only 30 losses. I don’t know about you, but that’s very few, and they are typically similar in nature. At least that’s my experience. So, all I needed to do now is to identify the reasons why those trades went wrong, then I know what to look for on the chart to prevent the bad trade from even being taken in the first place.

As opposed to Strategy Performance report #2, and trying to figure out the whopping 209 bad trades with a 1:1 ratio. But worst yet, think that my strategy sucks and dumping it.

In closing. I think the question is not, “What is the best Risk Reward Ratio?” The question is, “How good is my strategy, without a stop loss?”

Thoughts? Questions?

Happy Trading!

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  #2 (permalink)
SpeculatorSeth
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If you make your target and stop variables in the strategy you can have ninjatrader iterate across the different combinations to find the best one. Of course, this is curve fitting, but it's still an interesting exercise.

You'll find that increasing your stop almost always increases the strategy's performance. So why doesn't everyone do this? Well that's falling victim to one of the most common backtesting issues. Real world performance does not match backtesting performance. So even if you bactested across 5 years or more of data, there's a good chance of this kind of strategy blowing up if you go live. I don't know how exactly the market sniffs out your weakness, but they do it every time. I can't tell you how many traders I've seen trading in such a manner blow out in a single day. You'd think that a run of 10 or more losers in a row would be extremely unlikely but I've seen it more times than I can count.

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TWDsje View Post
You'll find that increasing your stop almost always increases the strategy's performance. So why doesn't everyone do this? Well that's falling victim to one of the most common backtesting issues. Real world performance does not match backtesting performance. So even if you bactested across 5 years or more of data, there's a good chance of this kind of strategy blowing up if you go live. I don't know how exactly the market sniffs out your weakness, but they do it every time. I can't tell you how many traders I've seen trading in such a manner blow out in a single day.

Sorry for the late response. Yes, I agree with you that if I were to use the same strategy going back 5 years it would not work. No strategy will. But that doesn’t mean your strategy is the problem.

Once a successful strategy is created, you still have to manage it, to keep it successful.

When I first created the strategy with the 87%-win rate (first post of this thread), I did a 3 year no stop loss backtest for two reasons. One, to know if the strategy worked way back when, and two, to know how to adjust the strategy to make it work during different times of the year as well as different market conditions. Once I figured that out, I was able to regain a win rate around the same percentage.

I guess you can call this part two to my exercise.

My method is to use a 3 period ATR, not a 14 period. The first thing I look at before trading is my ATR. When the ATR tells me that the last 3 bars are 1-3pts, my target is 2.5pts, 4-6pts my target is 5 pts, 7-10pts my target is 10pts, and if for example like in March 2020, the ATR read 20-30pts per bar, my target was 25pts.

I don’t want to go over the top and go through 5 years of backtesting because it is unnecessary. However, I am going to show you the validity of my point by demonstrating the performance of my strategy of 60 days in 2020 vs same 60 days in 2019 and how adjusting the target gave me a similar win rate in 2019 as in 2020.



Strategy Performance report #1 is 2019 with the 2020 profit target of 10pts. As you can see, the win rate for 2019 is not good. For Strategy Performance report #2, I have adjusted the target according to my ATR formula to fit the 2019 market conditions which is 2.5pts, and there you go 89%. As you already know, you cannot expect the same size wins or losses throughout the whole year, but with some minor adjustments to your targets, your strategy will work all the time as long as it is solid.

This holds true for bad strategies too. If it’s bad strategy, it will have bad results even if you have no stop loss. The key point here is to determine whether your strategy has successful entry points. The rest can be figured out later. More about that below.


TWDsje View Post
You'd think that a run of 10 or more losers in a row would be extremely unlikely but I've seen it more times than I can count.

As you say, it is very seldom. However, I wouldn’t take that chance either. As I explained in the first post of this tread, the losses are so few that it is easier to go through them and see what went wrong and secondly, 95% of the time they are usually the same style of bad entries.

To remedy this, all you do is back the chart up a few bars to see what that bad entry looks like before it completely forms so that you can visually spot and avoid them from ever happening. Thus, eliminating those “no stop loss” losses and drawdowns.

There are typically more things happening behind the scenes when it comes to a strategy so I do apologize for not painting a full picture the first time. Hopefully this clarifies things.

Anyways, this is what has been working for me. I just wanted to share my method of thinking so that it may help someone else figure things out whilst creating a strategy.

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SpeculatorSeth
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Madness View Post
When I first created the strategy with the 87%-win rate (first post of this thread), I did a 3 year no stop loss backtest for two reasons. One, to know if the strategy worked way back when, and two, to know how to adjust the strategy to make it work during different times of the year as well as different market conditions. Once I figured that out, I was able to regain a win rate around the same percentage.

That's what we call curve fitting. Adjusting to fit the data that happened in the past tells you nothing about how it will handle data in the future. We can't really even tell if the system has any edge outside of taking on excessive risk. It might have a high winrate, but that might be entirely due to having a wide stop.

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TWDsje View Post
That's what we call curve fitting. Adjusting to fit the data that happened in the past tells you nothing about how it will handle data in the future. We can't really even tell if the system has any edge outside of taking on excessive risk. It might have a high winrate, but that might be entirely due to having a wide stop.




How was your Friday TWDsje?

With all due respect, I have been using this particular strategy for 13 months, and I'm not here to argue with you about your way of seeing things. If you can't wrap your head around how this works, that doesn't mean it doesn't. I have seen other ways people trade and although I’ve been around since the dot com, I too cannot wrap my head around how they do it. But it works regardless of what I believe.

I’m not selling anything so I do not have to divulge my live strategy just to prove something to you. I posted this thread to for those who want to create a good or better strategy, but you have to have foresight. If you don’t, well my post is just not for you.

You have to understand that if I was to look at my current live strategy with your way of thinking, I would have dumped it thinking it doesn't work.

I will show you just 3 of the trades because I can't fit the whole chart with all 9 trades on Friday, it would be too squashed and not legible. For your inquisitive pleasure, I've taken off all my indicators.



There is nothing form fitting about what you see. I'm just accurately reaching for 10pts, and I've used the very same method that I describe in my second post on how to avoid losses, as much as possible.

Just like I said before. If you have a crap strategy, you can remove the stop all you want, but you will still get the same crap results. It's not the stops.

Stop loss disclaimer: I am not encouraging to not use stop losses. What I am trying to present is a way of testing if a strategy can work, prior to implementing a stop strategy. Place stops where you feel comfortable. I have a stop, but it is where I feel comfortable. I encourage you to do the same.

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SpeculatorSeth
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Madness View Post

With all due respect, I have been using this particular strategy for 13 months, and I'm not here to argue with you about your way of seeing things. If you can't wrap your head around how this works, that doesn't mean it doesn't. I have seen other ways people trade and although I’ve been around since the dot com, I too cannot wrap my head around how they do it. But it works regardless of what I believe.

I’m not selling anything so I do not have to divulge my live strategy just to prove something to you. I posted this thread to for those who want to create a good or better strategy, but you have to have foresight. If you don’t, well my post is just not for you.

I think I understand exactly how it works, and it's something that I've seen countless times before. They're always so confident that it's a workable strategy, but they always come back and admit to me that they blew the account. It's not uncommon to get away with it for years at a time, but the account blowout always comes. Strangely enough it sounds like you've already done it before. You claim to be in since dot com periods, but you've only been using this strategy for a year. How did the last blowout happen?

This is a common pitfall, and I've seen it ruin a lot of traders. So I'm always going to warn traders against this when I see it publicly. There are severe risks associated with such strategies. Trader beware!


Quoting 
There is nothing form fitting about what you see. I'm just accurately reaching for 10pts, and I've used the very same method that I describe in my second post on how to avoid losses, as much as possible.

Just like I said before. If you have a crap strategy, you can remove the stop all you want, but you will still get the same crap results. It's not the stops.

If there was anything "accurate" about your strategy you wouldn't need such a large stop.

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TWDsje View Post
I think I understand exactly how it works, and it's something that I've seen countless times before. They're always so confident that it's a workable strategy, but they always come back and admit to me that they blew the account. It's not uncommon to get away with it for years at a time, but the account blowout always comes. Strangely enough it sounds like you've already done it before. You claim to be in since dot com periods, but you've only been using this strategy for a year. How did the last blowout happen?

By the way, I was in my 30s when trading the dot com. I lost $5k in 5 minutes trading a company called Razor Fish. That was my first ever trade. That's when I decided to take the market on full time. So yeah, many things change over time, including when stock switched from fractions to decimals. Strategies change too.

I have many strategies, three of them I use every day. The reason I can make systematic trades is because computers account for the majority of market trades. If 100% of trades were done by humans, I'd be doing something else. There are no patterns in an emotional market. The more and more you stare at a screen, the more and more you see new patterns appear. I have quite a collection that I haven't even had the chance to test. The 13 month one is new. Most of the time I will replace a strategy that is harder to work with, with something easier like the 13 month one. Yes, the money is great, but for me it's more so the challenge of beating the market ever since I lost that first $5k. So, I come up with new strategies all the time.


TWDsje View Post
If there was anything "accurate" about your strategy you wouldn't need such a large stop.

You are painful to deal with. You could just ask, but you ask in a condescending manner. But I will answer and try to ignore your juvenile tone.

I never use stops, that’s my comfort, and I’m not alone. I have a large stop not because I don't trust the stratgy I built, it’s because I got bit trading stocks in 2010 by a flash crash. Today, I am not necessarily worried about another flash, but then again, I have seen a lot of crazy market moves, so I am aware that anything can happen, and that is the reason I have a 50pt catastrophic stop.

I added a small stop loss disclaimer on my second post to appease your warning cry to all traders.

Anyways, I hope you are done interviewing me. You’ve diluted my thread with YOUR religious trading beliefs, when in fact there are many ways to create and trade a strategy. I welcome questions but I do not welcome criticism of something you do not practice, or are closed minded about in the first place. You may not want to act as if you have all the answers. You are not the all mighty Gandhi of traders. No one is.

Now please TWDsje, if you have something worth my attention then ask away, but if you just want to just keep ragging on my methods with a smart-ass approach, then you’re not welcome.

As for anyone else, I am open for questions via direct message or here, so feel free to ask. I am happy to help in any way I can.

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SpeculatorSeth
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You'll never get a humble reply to the criticisms of such a strategy. The reason such traders employ these strategies is because it's too much for their ego to regularly take losses. There's nothing more to say about this other than trader beware!

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Hi Madness,

First, thank you so much for sharing your thoughts and backtest!

I am trading for 13 years (and still can't make it to profitability) I am profitable with my longer term bonds and stocks but with futures I keep struggling. But I promised myself I will make it before I die.. so never giving up

Recently I had similar thoughts.. I believe that my entries are good. I do see ES going my way for some time after I enter... however it would not reach 1:1 (or 1:2 etc) and stop me out, or stop me out quickly then go for many Rs... I am sure you get the point.

Now, with your great thread - it made me think again.. What if I try to work on high win rate instead... Just one question please -> you are saying that you do have a catastrophic stop of 50 points and on your NQ (9 trades) chart all your targets are 10 points.. Does that mean that your stop is only 5 times larger than target?? That is not too bad.. please clarify

Also, when you stuck in a trade that doesn't go your way but keeps going against you -> do you average down? I think second trade will help to get out of the first one (otherwise we are stuck with first trade for days....)

Hoping for any kind of input. Anyways, thank you so much for sharing your thoughts. Something for me to think about!

Thank you
Adilius

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Elite_Member
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Adilius View Post
Now, with your great thread - it made me think again.. What if I try to work on high win rate instead... Just one question please -> you are saying that you do have a catastrophic stop of 50 points and on your NQ (9 trades) chart all your targets are 10 points.. Does that mean that your stop is only 5 times larger than target?? That is not too bad.. please clarify

Also, when you stuck in a trade that doesn't go your way but keeps going against you -> do you average down? I think second trade will help to get out of the first one (otherwise we are stuck with first trade for days....)

Hope you're joking. Making 10pts on profitable trades, losing 50pts on stop outs you would need a win rate greater than 83% just to break even. And that is before commissions. Averaging down would make those losses even larger so need an even higher win rate just to maintain your account balance. You're increasing your risk simply to try to scratch a trade. Placing trades with large risk and no potential profit isn't a successful way to make money.

Also he was talking about the NQ and that can move fifty points against you in a few minutes. You wouldn't be stuck in the trade for days.

Trading, ideally structured, is a vehicle for expanding consciousness, not damaging it. - Brett Steenbarger
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The answer is 3.5:1 or anything between 3 and 4 to 1. I ran many simulations and this is the best value to use.


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SBtrader82 View Post
The answer is 3.5:1 or anything between 3 and 4 to 1. I ran many simulations and this is the best value to use.


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Can you share any of your study?

I've have never heard of a "best" r/r - given the amount of different strategies out there - so I am intrigued.

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kevinkdog View Post
Can you share any of your study?

I've have never heard of a "best" r/r - given the amount of different strategies out there - so I am intrigued.

yes sure!! First let me say that I think that there is no right or wrong in trading, so there is probably not an absolute optimal RR from a math standpoint. However if you do not scalp and you try to take some "reasonable" chunk out of the market, I think that most of the times anything in the range 3.5:1 to 4.5:1 risk reward is the best way to go.

I came to this conclusion first from a practical experience and second by build a very simple simulator.
You can see a thorough description of my experiment here:




In the experiment I was assuming that prices are "normally distributed" with variance equals 1. In this scenario the optimal value of RR depends on the stop that you use relative to the variance.
In practical terms you can think that the variance is the ATR of the day and you must assume that the stop cannot be too small compared to ATR. Thinking that your stop can be 0.05 when the variance is 1 would be unrealistic because it would mean that you can be extremely precise in your entry. Also your stop must be "reasonably big" compared to commissions. If you combine the theoretical results of the experiments with some practical experience you will probably arrive at the same conclusion.
Consider that in real life: you don't know what the daily range will be, you don't know the exact probability distribution of the market etc...

In the same thread I show a picture of the optimal RR for different values of the stop loss, see the results here:

Please don't misunderstand my experiment because it's not a "mathematical theory of everything", it's just a practical experiment that was meant to give me some hindsight. Also when I say a "optimal value" of RR, I mean something that can be right to use 85% of the days. Of course market is always changing and there are days in which you can ask the market a 10 times your risk, because there is a big trend.

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Hello Adilius, Sorry for the really late response.

So, before you can understand my stop loss you have to understand the meaning of my thread. The whole point to my thread is to be able to test a strategy without being unskewed by stop-losses that are usually triggered by market makers running stops.

There are 4 requirements I need to classify a strategy successful. These requirements are:
1) Your strategy has to give you a 90% or higher win rate. Meaning it reaches the price target.
2) Your trade only lasts at most a few minutes. (1 sec to 20 min)
3) It has to give you consistent backtesting results under normal market conditions for 60 days.

With that said, instructions on how to use the ATR to adjust to the current market conditions are explained in my post.

Now, once you’ve established that your strategy meets the 3 requirements above, there is requirement number 4. And that is to “trust your strategy". And while some may not like my trading style, “trust your strategy” is a quote that all traders use no matter their trading style.

If you run your strategy without a stop loss through a simulator, and it doesn’t reach your price target, then that strategy does not work. Even less with a stop loss.


Adilius View Post
you are saying that you do have a catastrophic stop of 50 points and on your NQ (9 trades) chart all your targets are 10 points.. Does that mean that your stop is only 5 times larger than target?? That is not too bad.. please clarify

As far as my stop loss, yes, it is there at every trade I place. BUT ONLY THERE for a sudden unforeseen movement in the market that could be due an important news flash, glitch, flash crash, whatever that takes the market out of normal conditions.


Adilius View Post
Also, when you stuck in a trade that doesn't go your way but keeps going against you -> do you average down? I think second trade will help to get out of the first one (otherwise we are stuck with first trade for days....)

And as far as a trade that goes against me, that 10%. I have written instruction in my post about that that 1 trade out of 10 that needs to be identified and eliminated before incurring a loss.

Lastly, as matthew28 says, never average down, especially with futures. I also never hold for a day or days. In and out the same day, and start fresh the next.

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SBtrader82 View Post
yes sure!! First let me say that I think that there is no right or wrong in trading, so there is probably not an absolute optimal RR from a math standpoint. However if you do not scalp and you try to take some "reasonable" chunk out of the market, I think that most of the times anything in the range 3.5:1 to 4.5:1 risk reward is the best way to go.

I came to this conclusion first from a practical experience and second by build a very simple simulator.
You can see a thorough description of my experiment here:




In the experiment I was assuming that prices are "normally distributed" with variance equals 1. In this scenario the optimal value of RR depends on the stop that you use relative to the variance.
In practical terms you can think that the variance is the ATR of the day and you must assume that the stop cannot be too small compared to ATR. Thinking that your stop can be 0.05 when the variance is 1 would be unrealistic because it would mean that you can be extremely precise in your entry. Also your stop must be "reasonably big" compared to commissions. If you combine the theoretical results of the experiments with some practical experience you will probably arrive at the same conclusion.
Consider that in real life: you don't know what the daily range will be, you don't know the exact probability distribution of the market etc...

In the same thread I show a picture of the optimal RR for different values of the stop loss, see the results here:

Please don't misunderstand my experiment because it's not a "mathematical theory of everything", it's just a practical experiment that was meant to give me some hindsight. Also when I say a "optimal value" of RR, I mean something that can be right to use 85% of the days. Of course market is always changing and there are days in which you can ask the market a 10 times your risk, because there is a big trend.


Thanks, I will take a look.

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SBtrader82 View Post
yes sure!! First let me say that I think that there is no right or wrong in trading, so there is probably not an absolute optimal RR from a math standpoint.

I absolutely agree with you here. The strategy I use in my post cannot use a 4.5:1 or 3:1 ratio. The results of the signal I use for the strategy in my post, is a maximum of 12-15 handles that it will quickly pop up or down. So using 10 handles as my price target is optimal, and the best I can get for that particular signal.

There is no one almighty R:R, only what our minds would like us to get as a reward or the standard R:R we read about online. But R:Rs have to be tailored not to what we would like to get, or whatever the “standard” is, but to what we can get.

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I absolutely agree with you here. The strategy I use in my post cannot use a 4.5:1 or 3:1 ratio. The results of the signal I use for the strategy in my post, is a maximum of 12-15 handles that it will quickly pop up or down. So using 10 handles as my price target is optimal, and the best I can get for that particular signal.

There is no one almighty R:R, only what our minds would like us to get as a reward or the standard R:R we read about online. But R:Rs have to be tailored not to what we would like to get, or whatever the “standard” is, but to what we can get.

You have a 90% win rate, for trades lasting 1 second to 20 minutes? What kind of net expectancy (or Tharp expectancy) does that generate?

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I don't understand the emphasis on the RR equation

Minimum Winrate = 1 / (1 + Reward:Risk)

A 1:1 RR = 50% winnings to break even point
A 4:1 RR = 20% winnings to break even point

Still a 50/50 proposition

Something else must be at play to win.

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trendisyourfriend View Post
I don't understand the emphasis on the RR equation

Minimum Winrate = 1 / (1 + Reward:Risk)

A 1:1 RR = 50% winnings to break even point
A 4:1 RR = 20% winnings to break even point

Still a 50/50 proposition

Something else must be at play to win.


And that is without costs factored in!

If you have 1:1 NET R:R, you have to win about 55% of time just to breakeven (depending on slippage and commissions).

So, yes I agree: Something else must be at play to win. (that's the edge you hopefully have).

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kevinkdog View Post
And that is without costs factored in!

If you have 1:1 NET R:R, you have to win about 55% of time just to breakeven (depending on slippage and commissions).

So, yes I agree: Something else must be at play to win. (that's the edge you hopefully have).

Exactly, this makes me think about a roulette player placing a token on the 2nd dozen bet. You bet one token to win two. He thinks, i have a good RR so let's play. slippage and commissions = zero numbers.


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SBtrader82 View Post
yes sure!! First let me say that I think that there is no right or wrong in trading, so there is probably not an absolute optimal RR from a math standpoint. However if you do not scalp and you try to take some "reasonable" chunk out of the market, I think that most of the times anything in the range 3.5:1 to 4.5:1 risk reward is the best way to go.

I came to this conclusion first from a practical experience and second by build a very simple simulator.
You can see a thorough description of my experiment here:




In the experiment I was assuming that prices are "normally distributed" with variance equals 1. In this scenario the optimal value of RR depends on the stop that you use relative to the variance.
In practical terms you can think that the variance is the ATR of the day and you must assume that the stop cannot be too small compared to ATR. Thinking that your stop can be 0.05 when the variance is 1 would be unrealistic because it would mean that you can be extremely precise in your entry. Also your stop must be "reasonably big" compared to commissions. If you combine the theoretical results of the experiments with some practical experience you will probably arrive at the same conclusion.
Consider that in real life: you don't know what the daily range will be, you don't know the exact probability distribution of the market etc...

In the same thread I show a picture of the optimal RR for different values of the stop loss, see the results here:

Please don't misunderstand my experiment because it's not a "mathematical theory of everything", it's just a practical experiment that was meant to give me some hindsight. Also when I say a "optimal value" of RR, I mean something that can be right to use 85% of the days. Of course market is always changing and there are days in which you can ask the market a 10 times your risk, because there is a big trend.

@SBtrader82
If you assume continuous market participation and use no filters or directional bias...Using a normally distributed market, your number are going to be pretty close.

In late 2018, I started to understand the value of standard deviation and the importance behind the Black Scholes model.

Using a simple 1 day standard deviation based on implied volatility and using no filters or directional bias, you can see with the calculations below a 2.8/1 WL ratio can be obtained. The calculations are made by not merging quarterly contracts (4 years worth)... Its also assumes continuous market participation and only trades one contract/order. I always include commissions and slippage is minimal at this time frame.



Capture



Although its not the best equity curve, it still produces decent profits. I stopped tracking it this way back in March of 2020, because I learned there are 2 ways you can improve the drawdowns and produce better profits. One is the fact that Volatility has skew. The other I will keep to myself. LOL

At one point, I tested this back nearly 15 years and it never stopped working. So to all those that think strategies stop working...Some things never change. Thanks Karl Pearson and you Black Scholes dudes.

So getting to the point...with a better understanding and using the 2 improvements, you can increase this to about 3.5/1 WL. This is very close to what you are assuming is best. Also knowing how to calculate standard deviation under different time frames, you will start to see this 3.5/1 keeps working at higher a lower time frames. That of course is limited as you near the extremities. There a additional factors that most be considered both ways.

In short, I agree that 3.5/1 is a very solid consistent ratio...But.

What happens when you add filters, directional bias, etc?

I have strats that out perform the one above and have higher and lower W/L ratios.

I might go as far to say its a median ratio looking at many strategies, But I wouldn't limit yourself!

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WoodyFox View Post
In short, I agree that 3.5/1 is a very solid consistent W/L ratio...But.

What happens when you add filters, directional bias, etc?

I have strats that out perform the one above and have higher and lower W/L ratios.

I might go as far to say its a median W/L ratio looking at many strategies, But I wouldn't limit yourself!

In other words, the optimal win loss ratio depends on the signal itself. It's also going to depend on your own goals. This is where other metrics become necessary. What was the max drawdown of the strategy? Can your account handle that? If you are holding for long periods of time what is the risk adjusted returns? It's not very useful when one person is talking about a market making strategy and someone else is showing a CTA strategy. They have completely different goals.

Which to the original point is why it is important to understand how these factors impact the overall system. Traders using low R strategies think they have a predictive signal when the expectancy of the system is largely due to taking on excess risk. That matters when you get into the drawdowns, and that's why it is so incredibly common to see these traders blow out. It's simply not suitable for the size and goal of the majority of retail accounts.

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TWDsje View Post
In other words, the optimal win loss ratio depends on the signal itself.

Maybe so.

The discussion is simple though...Do the markets have preferred ratios. We are simple collaborating the ideal that one does exist...That its possible the market is structured around a ratio that exists for some balanced statistical reason. We already know you can make money using such methods, why not make it a fun exercise right?

More often when finding edges, peeps will look to find what the market will give them. Sometimes its nice to set your own terms of what you would like to get and then wrap the market around that. I mentioned this once before on another thread and was questioned by a fellow successful trader (One that many would regard highly here) how the ideal of this was confusing to him. I could tell he was very off put by this and felt his scepticism. But the simple truth is a lot of good edges live around the 3.5 mark, and I agree this is a good goal to live around. I do not in any way limit myself there, but it can be a gauge if you will.

So back to your quote "In other words, the optimal win loss ratio depends on the signal itself".

Optimal to your signal or the Market itself? Can you tell the difference?

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WoodyFox View Post
Optimal to your signal or the Market itself? Can you tell the difference?

That depends on your definition of "optimal". Optimal total net profit? Optimal max drawdown? Optimal Sharpe ratio?

Which just proves my point. Optimal all depends on what you're trying to accomplish with your trading strategy. If your strategy maximizes total net profit but has a drawdown equal to that first, is it really optimal? Well, I can only tell you that I'm certainly not going to trade that strategy.

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TWDsje View Post
That depends on your definition of "optimal". Optimal total net profit? Optimal max drawdown? Optimal Sharpe ratio?

Which just proves my point. Optimal all depends on what you're trying to accomplish with your trading strategy. If your strategy maximizes total net profit but has a drawdown equal to that first, is it really optimal? Well, I can only tell you that I'm certainly not going to trade that strategy.

With all due respect, you have not disproved our exercise.

We are not debating you can get a strategy/edge to produce numbers that fit your capital or any other parameters needed to fit your scenario. This point any profitable trader already knows.
We are simply asking if there is a preferred ratio the market is structured around. One that is optimal for statistical reasons based off a normally distributed (or not) market. A balance if you will.
3.5 has been proposed here...Can you disprove this. You do seem all against the notion of it.

Remember a theory is treated with respect until disproven JMHO

Either way, I respect your opinion. I'm also not sure there is an optimal ratio either, but I do like the discussion.

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WoodyFox View Post
With all due respect, you have not disproved our exercise.

We are not debating you can get a strategy/edge to produce numbers that fit your capital or any other parameters needed to fit your scenario. This point any profitable trader already knows.
We are simply asking if there is a preferred WL ratio the market is structured around. One that is optimal for statistical reasons based off a normally distributed (or not) market. A balance if you will.
3.5 has been proposed here...Can you disprove this. You do seem all against the notion of it.

Remember a theory is treated with respect until disproven JMHO

Either way, I respect your opinion. I'm also not sure there is an optimal ratio either, but I do like the discussion.

Right so let me try this again. You have to define optimal. Without a strict definition of what qualifies as optimal there's nothing to prove or disprove because you don't have a full theory. There's no function for us to optimize.

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TWDsje View Post
Right so let me try this again. You have to define optimal. Without a strict definition of what qualifies as optimal there's nothing to prove or disprove because you don't have a full theory. There's no function for us to optimize.

I'm sorry, have you read the whole thread. Did I or did I not start in on the conversation by quoting one of SBtrader85 studies?


And Look at post #11 where he specifically proposes a 3.5 Ratio...


Capture




Are you sure you are on the right thread? Because your confusing me dude...LOL

I also just asked you to disprove 3.5 just 2 post ago?




Probably just confusion... So no harm, lets move on.

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WoodyFox View Post
@SBtrader82
If you assume continuous market participation and use no filters or directional bias...Using a normally distributed market, your number are going to be pretty close.

In late 2018, I started to understand the value of standard deviation and the importance behind the Black Scholes model.

Using a simple 1 day standard deviation based on implied volatility and using no filters or directional bias, you can see with the calculations below a 2.8/1 WL ratio can be obtained. The calculations are made by not merging quarterly contracts (4 years worth)... Its also assumes continuous market participation and only trades one contract/order. I always include commissions and slippage is minimal at this time frame.



Capture



Although its not the best equity curve, it still produces decent profits. I stopped tracking it this way back in March of 2020, because I learned there are 2 ways you can improve the drawdowns and produce better profits. One is the fact that Volatility has skew. The other I will keep to myself. LOL

At one point, I tested this back nearly 15 years and it never stopped working. So to all those that think strategies stop working...Some things never change. Thanks Karl Pearson and you Black Scholes dudes.

So getting to the point...with a better understanding and using the 2 improvements, you can increase this to about 3.5/1 WL. This is very close to what you are assuming is best. Also knowing how to calculate standard deviation under different time frames, you will start to see this 3.5/1 keeps working at higher a lower time frames. That of course is limited as you near the extremities. There a additional factors that most be considered both ways.

In short, I agree that 3.5/1 is a very solid consistent ratio...But.

What happens when you add filters, directional bias, etc?

I have strats that out perform the one above and have higher and lower W/L ratios.

I might go as far to say its a median ratio looking at many strategies, But I wouldn't limit yourself!

@WoodyFox that's really interesting... in the thread "the war of two world" someone made a similar experiment in another market, but the results were not so positive. I am glad to discover that my intuition about the optimal risk reward can be backtested in the market.

Can you explain how you take the trades in your experiment? you mentioned that there is no directional bias, do you mean that you take random trades that can be either long or short?

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WoodyFox View Post
Maybe so.

The discussion is simple though...Do the markets have preferred ratios. We are simple collaborating the ideal that one does exist...That its possible the market is structured around a ratio that exists for some balanced statistical reason. We already know you can make money using such methods, why not make it a fun exercise right?

More often when finding edges, peeps will look to find what the market will give them. Sometimes its nice to set your own terms of what you would like to get and then wrap the market around that. I mentioned this once before on another thread and was questioned by a fellow successful trader (One that many would regard highly here) how the ideal of this was confusing to him. I could tell he was very off put by this and felt his scepticism. But the simple truth is a lot of good edges live around the 3.5 mark, and I agree this is a good goal to live around. I do not in any way limit myself there, but it can be a gauge if you will.

So back to your quote "In other words, the optimal win loss ratio depends on the signal itself".

Optimal to your signal or the Market itself? Can you tell the difference?

@WoodyFox I like this sentence a lot: "But the simple truth is a lot of good edges live around the 3.5 mark ", I couldn't express it any better!!

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WoodyFox View Post
I'm sorry, have you read the whole thread. Did I or did I not start in on the conversation by quoting one of SBtrader85 studies?

So then just admit you're talking about total net profit? Why is that so hard? Or is it because you know that it just leads us down the same path?

For instance, what if I decided to make my reward factor infinity? That means I'll buy it and hold it forever. Or maybe slightly less ridiculous I'll buy at the start of the decade and hold it for 10 years. That should probably give me a pretty high reward factor.

At which point you might say that those examples are silly, and don't help to answer the purpose of the experiment. Which means that you have to put limitations on it. Like the strategy needs to take a certain number of trades over the sample period. And those limitations are why you get the answers that you do.

It's not because the market lends itself towards one ratio or the other. There is an infinite number of profitable strategies, and any single strategy could have whatever reward factor you want. So why do you get the reward factors you do when you optimize your backtests? It all just depends on where you were looking in the first place.

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TWDsje View Post
So then just admit you're talking about total net profit? Why is that so hard? Or is it because you know that it just leads us down the same path?

For instance, what if I decided to make my reward factor infinity? That means I'll buy it and hold it forever. Or maybe slightly less ridiculous I'll buy at the start of the decade and hold it for 10 years. That should probably give me a pretty high reward factor.

At which point you might say that those examples are silly, and don't help to answer the purpose of the experiment. Which means that you have to put limitations on it. Like the strategy needs to take a certain number of trades over the sample period. And those limitations are why you get the answers that you do.

It's not because the market lends itself towards one ratio or the other. There is an infinite number of profitable strategies, and any single strategy could have whatever reward factor you want. So why do you get the reward factors you do when you optimize your backtests? It all just depends on where you were looking in the first place.

Listen, I'm tired of explaining the same thing over and over. We are not looking for a pretty high reward factor. And no the examples are not silly . If you would read the posts in there entirety, you would notice post 22 and I quote

"Also knowing how to calculate standard deviation under different time frames, you will start to see this 3.5/1 keeps working at higher a lower time frames. That of course is limited as you near the extremities. There are additional factors that must be considered both ways."

I repeat for the nth time... No one is saying there aren't a gazillion things that can change a risk reward ratio. We are simply entertaining a fun experiment to delve into the conception of some optimal risk reward ratio that is best fitting to a market in most conditions. Whether this exist is just an experiment. You my friend, with emotion, are clearly against the ideal of this. I share some of your doubts. But I must confess, you wear me out and have made it no longer a fun experiment. LOL.

Don't take this personal, I think you just didn't understand the thread as the way I do.

Stay well my friend... we will cross in another thread and then we will see I to I.

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I repeat for the nth time... No one is saying there aren't a gazillion things that can change a risk reward ratio. We are simply entertaining a fun experiment to delve into the conception of some optimal risk reward ratio that is best fitting to a market in most conditions. Whether this exist is just an experiment. You my friend, with emotion, are clearly against the ideal of this. I share some of your doubts. But I must confess, you wear me out and have made it no longer a fun experiment. LOL.

Don't take this personal, I think you just didn't understand the thread as the way I do.

I don't think you understand what I'm saying at all. I didn't say that an optimal ratio doesn't exist. I'm saying the question doesn't make any mathematical sense. It's like saying optimize the volume of this cube. Ok I'll make the cube have a length of infinity. Optimization only makes sense if there are additional constraints.

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I don't think you understand what I'm saying at all. I didn't say that an optimal ratio doesn't exist. I'm saying the question doesn't make any mathematical sense. It's like saying optimize the volume of this cube. Ok I'll make the cube have a length of infinity. Optimization only makes sense if there are additional constraints.


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Start date = 20 July 2020
Number of trades = 532
Timeframe = 60min
Symbol = ES
Size = 1 contract
slip = 2 ticks
commission = 2 ticks
Direction = long only
Stop = 13 points
Target = 25 points

Only 1 trade in the market at a time. Trade opens only when prior one has hit target or stopped out.


To test the 1:2 risk reward ratio.

1hr

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I, like OPoster, have been trading since prior to the DotBomb 2000 collapse and don't use Reward/Risk as a trading metric. Price does what it does, not what some formula says it should. But what I do use is PriceAction (what some call structure) to place and adjust stops and targets - as well as have a backup catastrophic stop in the event wild things develop rapidly.

My only 2 cents for this topic ... I think.

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One issue I can see with this method is that it would be very difficult to trade with large leverage. My personal goal in trading is to increase leverage and run strategies that allow trading massive size. In order to do this, my objective is to continuously reduce my stop distance while simultaneously increasing win rate.

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SunTrader View Post
I, like OPoster, have been trading since prior to the DotBomb 2000 collapse and don't use Reward/Risk as a trading metric. Price does what it does, not what some formula says it should. But what I do use is PriceAction (what some call structure) to place and adjust stops and targets - as well as have a backup catastrophic stop in the event wild things develop rapidly.

My only 2 cents for this topic ... I think.

No formulas. Market structure is involved in most of my edges.
Any strategy that has stood the test of time, has been ones that have a basis for structure that stay consistent. They are walked forward using market volatility. I have used different ways to approach this but they are just different ways of finding the same thing. What if they perform best (through out time) at a 3.5 ratio regardless of when the standard deviation expands and contracts (shifting stops and targets), or when moving the strategy to smaller and higher time frames.

So as you trade, and your ratio's change when SR changes...do you ever feel that if you would have only picked trades with same ratio, at the end of the year you would be at the same place? I do not discretionary trade and I'm curious of a discretionary traders confidence (in a way jealous of this confidence). Obviously you do well and I do understand a lot of traders have a knake for trading this way.

I also am not admitting there is some best ratio. I will not rule it out though.

But...
The more 6/1 trades you take their probability starts falling and as you work your way to the 1/1 ratio you start loosing sight of your edge.

What if the market has a consistent median in there somewhere? I think its a good question.

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@Madness

The initial post here is interesting and should be source for meaningful discussion. I really appreciate that @Big Mike has found a way to hit my inbox with interesting threads as I would not see this unless I'm tagged.

I have very limited time today and will be out tomorrow so I'm going to delay a detailed response until I can read the entire thread.

You are on to some interesting questions that I certainly have an opinion on. Two primary trading emotions are "greed" represented by taking a position, and "fear" represented often by a resting stop loss. It has been demonstrated that random entries combined with brilliant and disciplined risk management can make money over time. I've commented here before that a system is spurious and that it is the risk detail that is producing "alpha". IMO approach to risk is maybe the most debased topic in all of retail trading.

If anyone cares to entertain that discussion tag me in this thread and I will be able to engage early next week.

Everyone, trade well and be well.

-Dan

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  #40 (permalink)
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Notice the attached Monte Carlo analysis. Trade long enough and you are guaranteed at least 5 losses in a row.
With a black swan event of 20+ losses in a row.

Attached Files
Register to download File Type: pdf Final.pdf (79.0 KB, 26 views)
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  #41 (permalink)
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Thanks for posting, it's an interesting topic. A few thoughts I have...

- No stop (or very large stop) strategies are brutal psychologically. I prefer my job to be low-stress. I was a "gunslinger" back in the day; ran no stops and whatnot and the bad days are....bad.

- I believe there is a place for no stop strategies but I would argue that options are a better way to use them. Cheap OTM long calls/puts can do a lot of work for you with exact risk controls. Obviously you would have to alter your trade frequency, slippage, etc. but SPY weeklies are a viable vehicle for intraday trading.

- If you're having a big problem getting stopped out than you need to work on your entries. Order book and footprint/heatmap tools are excellent for finding precise entries and possible stop run locations.

- Listen to most professional traders who have been consistent over long stretches and you'll hear a common refrain; TAKE LOSSES EARLY. You can back test all day long with incredible results but if you're trading full-time you will eventually get bit with a bad run. Why stress over that?

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  #42 (permalink)
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Hi there,

Thanks for sharing your set up.

Is this a strategy you developed?

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  #43 (permalink)
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DaretoDo View Post
Thanks for posting, it's an interesting topic. A few thoughts I have...

- No stop (or very large stop) strategies are brutal psychologically. I prefer my job to be low-stress. I was a "gunslinger" back in the day; ran no stops and whatnot and the bad days are....bad.

- I believe there is a place for no stop strategies but I would argue that options are a better way to use them. Cheap OTM long calls/puts can do a lot of work for you with exact risk controls. Obviously you would have to alter your trade frequency, slippage, etc. but SPY weeklies are a viable vehicle for intraday trading.

- If you're having a big problem getting stopped out than you need to work on your entries. Order book and footprint/heatmap tools are excellent for finding precise entries and possible stop run locations.

- Listen to most professional traders who have been consistent over long stretches and you'll hear a common refrain; TAKE LOSSES EARLY. You can back test all day long with incredible results but if you're trading full-time you will eventually get bit with a bad run. Why stress over that?

Good points, but I'm not sure anybody is suggesting only no stop strats to find a best Risk Reward ratio. Just whether a best ratio exists?

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WoodyFox View Post
Good points, but I'm not sure anybody is suggesting only no stop strats to find a best Risk Reward ratio. Just whether a best ratio exists?

The original post is suggesting no/large stops unless I'm reading it wrong which may very well be the case! :-)

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DaretoDo View Post
The original post is suggesting no/large stops unless I'm reading it wrong which may very well be the case! :-)

Sorry, I do see that now. I'm to caught up in the details of best Risk Reward. LOL

So I do agree more with you on this point to the original poster.

Mean reversion strats are easy to build without stops, but like you said the MAE can be painful.

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Big Mike View Post
@Madness, just wanted to say I like your avatar

Well thank you Mike. It's part of my trading firm logo.

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Madness View Post



How was your Friday TWDsje?

With all due respect, I have been using this particular strategy for 13 months, and I'm not here to argue with you about your way of seeing things. If you can't wrap your head around how this works, that doesn't mean it doesn't. I have seen other ways people trade and although I’ve been around since the dot com, I too cannot wrap my head around how they do it. But it works regardless of what I believe.

I’m not selling anything so I do not have to divulge my live strategy just to prove something to you. I posted this thread to for those who want to create a good or better strategy, but you have to have foresight. If you don’t, well my post is just not for you.

You have to understand that if I was to look at my current live strategy with your way of thinking, I would have dumped it thinking it doesn't work.

I will show you just 3 of the trades because I can't fit the whole chart with all 9 trades on Friday, it would be too squashed and not legible. For your inquisitive pleasure, I've taken off all my indicators.



There is nothing form fitting about what you see. I'm just accurately reaching for 10pts, and I've used the very same method that I describe in my second post on how to avoid losses, as much as possible.

Just like I said before. If you have a crap strategy, you can remove the stop all you want, but you will still get the same crap results. It's not the stops.

Stop loss disclaimer: I am not encouraging to not use stop losses. What I am trying to present is a way of testing if a strategy can work, prior to implementing a stop strategy. Place stops where you feel comfortable. I have a stop, but it is where I feel comfortable. I encourage you to do the same.


Madness... intrigued by your strategy. Do you use it on a 1 minute chart? What triggers the entry? Thanks in advance.

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  #48 (permalink)
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WoodyFox View Post
Maybe so.

The discussion is simple though...Do the markets have preferred ratios. We are simple collaborating the ideal that one does exist...That its possible the market is structured around a ratio that exists for some balanced statistical reason. We already know you can make money using such methods, why not make it a fun exercise right?

More often when finding edges, peeps will look to find what the market will give them. Sometimes its nice to set your own terms of what you would like to get and then wrap the market around that. I mentioned this once before on another thread and was questioned by a fellow successful trader (One that many would regard highly here) how the ideal of this was confusing to him. I could tell he was very off put by this and felt his scepticism. But the simple truth is a lot of good edges live around the 3.5 mark, and I agree this is a good goal to live around. I do not in any way limit myself there, but it can be a gauge if you will.

So back to your quote "In other words, the optimal win loss ratio depends on the signal itself".

Optimal to your signal or the Market itself? Can you tell the difference?

The standard estimation for how long it takes a business to be profitable is about two to three years.

A 15%-20% profit margin for a business is considered good.

In trading, the baseline is 3.5-4:1. What were the parameters that concluded that? Was it any of our chart setups or our in and out signals? No, it’s not.

All three of these “standards” above are no different than the standard 2 ply toilet paper. There has to be a standard. We need a baseline to measure perfomance.

Whether it is doing business or trading, if you use a standard approach, you'll get standard results. I on the other hand, like to wipe my ass with 5 ply toilet paper.

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  #49 (permalink)
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Madness View Post
The standard estimation for how long it takes a business to be profitable is about two to three years.

A 15%-20% profit margin for a business is considered good.

In trading, the baseline is 3.5-4:1. What were the parameters that concluded that? Was it any of our chart setups or in and out signals? No, it’s not.

All three of these “standards” above are no different than the standard 2 ply toilet paper. There has to be a standard. We need a baseline to measure perfomance.

Whether it is doing business or trading, if you use a standard approach, you'll get standard results. I on the other hand, like to wipe my ass with 5 ply toilet paper.

LOL. Heck what about 10 ply tires. Use those for awhile and you better get more TP.

3.5/1...350% even with 66% bad product? No overhead and worrying whether you keep the doors open during Covid.

They can keep their 15 to 20 profit margin.

But I do get your point.

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  #50 (permalink)
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WoodyFox View Post
Listen, I'm tired of explaining the same thing over and over. We are not looking for a pretty high reward factor. And no the examples are not silly . If you would read the posts in there entirety, you would notice post 22 and I quote

"Also knowing how to calculate standard deviation under different time frames, you will start to see this 3.5/1 keeps working at higher a lower time frames. That of course is limited as you near the extremities. There are additional factors that must be considered both ways."

I repeat for the nth time... No one is saying there aren't a gazillion things that can change a risk reward ratio. We are simply entertaining a fun experiment to delve into the conception of some optimal risk reward ratio that is best fitting to a market in most conditions. Whether this exist is just an experiment. You my friend, with emotion, are clearly against the ideal of this. I share some of your doubts. But I must confess, you wear me out and have made it no longer a fun experiment. LOL.

Don't take this personal, I think you just didn't understand the thread as the way I do.

Stay well my friend... we will cross in another thread and then we will see I to I.

My original post is meant to open minds into thinking outside of the box. If this approach works for me, it can work for others. But clearly, some people just don’t get it. They just regurgitated “standard” remarks, related to standard trading, found on the standard internet. God forbid you attempt to deviate from their flat earth thinking, they will beat you with a stick until you comply to their indoctrination. Stay open minded, and keep experimenting.

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Madness View Post
My original post is meant to open minds into thinking outside of the box. If this approach works for me, it can work for others. But clearly, some people just don’t get it. They just regurgitated “standard” remarks, related to standard trading, found on the standard internet. God forbid you attempt to deviate from their flat earth thinking, they will beat you with a stick until you comply to their indoctrination. Stay open minded, and keep experimenting.

Ok so now we're getting the standard guru platitudes. People just don't understand and only the truly enlightened will join me! He's even making specific performance claims without posting broker statements. Not to mention suspicious accounts that have never posted before expressing interest. How long until he starts promoting his service and sending people PM's?

Don't let this smokescreen distract you from the fact that there are severe disadvantages to trading with a low reward factor. Such strategies tend to have hard drawdowns, and are not appropriate for most retail accounts. Despite all his talk about breaking from the standard, this is quite a common strategy that retail traders fall victim to.

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TWDsje View Post
Ok so now we're getting the standard guru platitudes.

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Madness View Post
My original post is meant to open minds into thinking outside of the box. If this approach works for me, it can work for others. But clearly, some people just don’t get it. They just regurgitated “standard” remarks, related to standard trading, found on the standard internet. God forbid you attempt to deviate from their flat earth thinking, they will beat you with a stick until you comply to their indoctrination. Stay open minded, and keep experimenting.


Bad times are coming for you ............

Good luck, mate!

And thank you!. Good idea for a thread and thinking around Trading.

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  #54 (permalink)
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Madness View Post
This is the first thread that I am starting here on Future.io so before I get into it, I wanted to say thanks to Big Mike and the whole Futures.io community. I have soaked in a lot information from this great forum and I am grateful for all of you whom have shared your experiences so that we can keep learning.

Also, please keep in mind that this is my unorthodox approach to this risk reward topic. Use at your own risk. I just wanted to share how I personally devise a risk reward strategy before going live. This method works very well for me but may not work for you or your style of trading. There are many creative ways to look at things when devising a risk reward strategy and this is just another one of those.

The same question pops all the time: What is the best Risk Reward Ratio? But is that the right question?

At one time or another most traders will ask themselves that very same question. And honestly, it’s a tough one to answer considering all the different variables involved with trading. But there is (at least I feel) a way to answer this question, but from a different perspective. One that does not directly focus on the risk part at all, at first.

I trade the NQ and I do not use stop losses. However, I do have a 50-pt catastrophic stop loss, but I do not include it when building and back testing a strategy. More on that later.

One of my strategies is where I shoot for a 10-pt profit target. Back in the day, I also tried the 1:1, but it wasn't until I completely removed the common “risk reward" stop loss that I went to an 85%+ win rate on the strategy alone. I also managed to pick up another ±10% of profitability bumping it up to a ± 95% win rate, which I’ll also explain later.

So why no stop loss is better? For two reasons. Your trade needs breathing room, and you have to account for running of stops.

Let's hypothetically say that you have insider information telling you that the price is headed to an important price level. Well, even though you now know where it's going, I’m sure you can agree that it will not get there in a in a straight line. Instead, there will be many peaks and valleys along the way. Those peaks and valleys are designed to take your money while in transit to that important price level.

The key for me is having a fully back tested strategy that is proven successful during normal market conditions but without having any stop loss. That’s right, no conventional stop loss. With that said, a stop loss does needs to be part of your strategy, but it should not get in the way of making profit. Instead, it should help you when you truly need it.

Try this. Back test your strategy with no stop loss at all, and see if your trade would actually reach your profit target. Don't pay attention to the actual loss amount for now. If your trade wins vs losses percentage is bad, then your strategy was bad from the start and needs to be either optimized or scrapped all together. For me personally, if a new strategy that I created cannot get good back testing results without a stop loss, then I didn’t work hard enough on that strategy.

In trading, talk is cheap, so I wanted to share the 60-day back testing results on a strategy I created using 3 NQ contracts.



Strategy Performance report #1 shows my strategy results without any stop losses used. The Strategy Performance report #2 of the same strategy are the results of a 1:1 risk reward ratio. I know what you’re thinking; what about using a 1:2, or 1:3 ratio, or, 2:2, or 3:3 ratio? Been there done tested that, none of them work. At least not for this specific strategy.

Two points I want to cover from earlier. One is that 50-pt stop loss. When testing a strategy, I do not include it into the strategy building because it’s just like the 1:1, or 1:2, it doesn’t work and it would falsely skew my results into negative territory where I would believe that my strategy either sucks or just flat out doesn’t work. This is clearly demonstrated with Strategy Performance report #2 when using 1:1. The 50-pt stop is only there for catastrophic reasons during live trading.

Secondly, how do I squeeze another ±10% of profit and avoid those drawdowns? Looking at Strategy Performance report #1 (without stop loss), you will see the number of wins and losses. Well, there are only 30 losses. I don’t know about you, but that’s very few, and they are typically similar in nature. At least that’s my experience. So, all I needed to do now is to identify the reasons why those trades went wrong, then I know what to look for on the chart to prevent the bad trade from even being taken in the first place.

As opposed to Strategy Performance report #2, and trying to figure out the whopping 209 bad trades with a 1:1 ratio. But worst yet, think that my strategy sucks and dumping it.

In closing. I think the question is not, “What is the best Risk Reward Ratio?” The question is, “How good is my strategy, without a stop loss?”

Thoughts? Questions?

Happy Trading!

From what I seen from your post, I'll give you some of my insight. Starting from the beginning to the end. Trading futures especially NQ/RTY/ES/CL etc. Stop losses are strictly needed. A mental stop doesn't cut it, and especially since you have not tested this system on a LIVE account just a demo, they are two different ball games. Trading NQ without a stop loss especially with how volatile the markets are on a live account without much experience (sorry not trying to be mean just reality) is very dangerous. Now, we as retailers/majority of firms still cannot move Index prices in major ways. Looking at your 60-day backtest results, I would pick the stop loss one in a heart beat. Your Avg winning trade is $597 w/o Stop Loss, while your Avg losing trade is $2200 w/o Stop Loss. Your largest winning trade was $600 w/o Stop Loss and your largest losing trade was $6600 w/o Stop Loss. These are just some but very important red flags I noticed. Even tho you have more trades using a stop loss which makes it harder to compare to using no stop loss. Your avg winning trade was $595 with a stop loss. Your avg was $597 losing trade with a stop loss. Largest winning trade was $600 with a stop loss. Largest losing trade was $600 with a stop loss. Any average person looking at these two and comparing them can tell you trading with a stop loss is better. Using a stop loss gives you a base to your system, and then you work based around your stop loss. When I look at a trade placing my stop loss is the first thing I want to see, knowing where to place it defines the rest of the R/R makes me think is it worth it to take the trade or not. It will save you a TON of stress in the future to use stop losses. But if you can handle mental stops all the power to you.

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  #55 (permalink)
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outlawx View Post
Sorry don't have enough messages to quote your post.

From what I seen from your post, I'll give you some of my insight. Starting from the beginning to the end. Trading futures especially NQ/RTY/ES/CL etc. Stop losses are strictly needed. A mental stop doesn't cut it, and especially since you have not tested this system on a LIVE account just a demo, they are two different ball games. Trading NQ without a stop loss especially with how volatile the markets are on a live account without much experience (sorry not trying to be mean just reality) is very dangerous. Now, we as retailers/majority of firms still cannot move Index prices in major ways. Looking at your 60-day backtest results, I would pick the stop loss one in a heart beat. Your Avg winning trade is $597 w/o Stop Loss, while your Avg losing trade is $2200 w/o Stop Loss. Your largest winning trade was $600 w/o Stop Loss and your largest losing trade was $6600 w/o Stop Loss. These are just some but very important red flags I noticed. Even tho you have more trades using a stop loss which makes it harder to compare to using no stop loss. Your avg winning trade was $595 with a stop loss. Your avg was $597 losing trade with a stop loss. Largest winning trade was $600 with a stop loss. Largest losing trade was $600 with a stop loss. Any average person looking at these two and comparing them can tell you trading with a stop loss is better. Using a stop loss gives you a base to your system, and then you work based around your stop loss. When I look at a trade placing my stop loss is the first thing I want to see, knowing where to place it defines the rest of the R/R makes me think is it worth it to take the trade or not. It will save you a TON of stress in the future to use stop losses. But if you can handle mental stops all the power to you.

I couldn't agree more. It took me years to accept that hard stops are necessary. Most of the time you can get away without stops, the problem is that one unlucky situation might blow up your account.

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SBtrader82 View Post
I couldn't agree more. It took me years to accept that hard stops are necessary. Most of the time you can get away without stops, the problem is that one unlucky situation might blow up your account.

You can get away with it for so long before it catches up to you. This strategy imo would work better in the equities market with a ton of research and back testing. But I also do not know how he trades and how his trading style is to assume anything more.

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  #57 (permalink)
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TWDsje View Post
I don't think you understand what I'm saying at all. I didn't say that an optimal ratio doesn't exist. I'm saying the question doesn't make any mathematical sense. It's like saying optimize the volume of this cube. Ok I'll make the cube have a length of infinity. Optimization only makes sense if there are additional constraints.

OK. If at this point anyone that doesn't understands what TWDsje is saying isnt going to get it.

That is such a beautiful quote!!!

And I just love this.... "Optimize the volume of this cube."

Lol. Thank you TWDsje

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  #58 (permalink)
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shokunin View Post
One issue I can see with this method is that it would be very difficult to trade with large leverage. My personal goal in trading is to increase leverage and run strategies that allow trading massive size. In order to do this, my objective is to continuously reduce my stop distance while simultaneously increasing win rate.

This took me SOOO long to realize and was the reason its taken me so long to get profitable. (Not consistent yet) but better results than ever before.

Another detriment was trading micros. I was taking WAY TOO MUCH RISK because of the small size. If I leveraged those strategies into the minis I'd be utterly destroyed.

Now Im trying to keep losses small by playing defense but even more so taking small profits along the way. Its extremely hard and I still can't believe it's working because it doesn't make intuitive sense but it works.

And in fact its basically opposite of what Ive done for the last 6 years. Ive ALWAYS tried to go for a 2/1 plus ratio. Hasn't ever worked long term. I always end up with small winners and more AND larger losers. Not a great strategy. Whatever.

And it suits me as I %100 believe entries aren't really that important as you never really know where the markets going (plus it depends on stop loss/target/volatility/emotions/goals ect) taking small profits and painfully cutting those losses has worked AS a strategy.

Its hard to believe you can profit by taking so many losses but maybe thats why it works. (My initial stop is 2.5 times my target. BUT now I NEVER let that get hit.) Again opposite of what I was doing.

Wow don't know where all that came from. Cheers

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  #59 (permalink)
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With all do respect....

"I didn't say that an optimal ratio doesn't exist. I'm saying the question doesn't make any mathematical sense"

So he agrees it could exist, but does not understand it mathematically...isn't that the point of the exercise?


On a side note.
There is 2 things going on in the thread. Some best market RR ratio and the ideal of trading without a stop to get a best RR ratio.

I agree on the no stop and having dangerous MAE.

But a good mean reversion strategy that is found with out stops can be made more desirable with lower risk of high MAEs Especially when dealing in a market with higher IV. There are ways to do this. Not full fixes, but certainly tradeable fixes.
Sandpaddict View Post
OK. If at this point anyone that doesn't understands what TWDsje is saying isnt going to get it.

That is such a beautiful quote!!!

And I just love this.... "Optimize the volume of this cube."

Lol. Thank you TWDsje

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  #60 (permalink)
Langley
 
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wldman View Post
@Madness

The initial post here is interesting and should be source for meaningful discussion. I really appreciate that @Big Mike has found a way to hit my inbox with interesting threads as I would not see this unless I'm tagged.

I have very limited time today and will be out tomorrow so I'm going to delay a detailed response until I can read the entire thread.

You are on to some interesting questions that I certainly have an opinion on. Two primary trading emotions are "greed" represented by taking a position, and "fear" represented often by a resting stop loss. It has been demonstrated that random entries combined with brilliant and disciplined risk management can make money over time. I've commented here before that a system is spurious and that it is the risk detail that is producing "alpha". IMO approach to risk is maybe the most debased topic in all of retail trading.

If anyone cares to entertain that discussion tag me in this thread and I will be able to engage early next week.

Everyone, trade well and be well.

-Dan



I have not finished reading all posts here but this stopped me in my tracks as you said a few things that resonated very strongly with me.

"Greed -> take position. Stop loss -> fear" WOW! So true!

I have said many times and repeat in different ways in almost every post. Entries are the least important part of a system (whatever the system).

The risk management part of the system is where the money is made. As you said a random entry system with GREAT management can be profitable in the long run. Try reversing that. Try to take great entries (whatever that means. An entry only makes sense in relation to the exit.) And throw risk out the window. We all know how that ends.

These are only my beliefs but I really would like your opinion as it is also what I believe.

I am no expert. I am not trading real money again till Im consistently profitable but my focus is %95 on the management AFTER entry! Not before.

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  #61 (permalink)
Langley
 
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datahogg View Post
Notice the attached Monte Carlo analysis. Trade long enough and you are guaranteed at least 5 losses in a row.
With a black swan event of 20+ losses in a row.

AKA... the longer you trade the larger the chance you'll see a larger drawdown then ever before. (Think LTCM) I think they STILL claim it couldn't happen in many many lifetimes)

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  #62 (permalink)
Langley
 
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WoodyFox View Post
Good points, but I'm not sure anybody is suggesting only no stop strats to find a best Risk Reward ratio. Just whether a best ratio exists?

Umm. I'm not sure about that. The original poster claims he uses ATR profit targets within volatility and 50 point stops.

It broke off into a discussion about a universally good R/R.

My beliefs about that are just like TWDsje said earlier. Sure there is but WHAT ARE THE CONSTRAINTS? Type your parameters into your backtesting engine and it'll spit it out. Then do it over many many. Like probably thousands of iterations of those parameters and average over all of them. Again its just a number. An average.

What does that mean. Nothing other than thats what happend in the past.

Just my 2 cents.

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Langley
 
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Madness View Post
The standard estimation for how long it takes a business to be profitable is about two to three years.

A 15%-20% profit margin for a business is considered good.

In trading, the baseline is 3.5-4:1. What were the parameters that concluded that? Was it any of our chart setups or our in and out signals? No, it’s not.

All three of these “standards” above are no different than the standard 2 ply toilet paper. There has to be a standard. We need a baseline to measure perfomance.

Whether it is doing business or trading, if you use a standard approach, you'll get standard results. I on the other hand, like to wipe my ass with 5 ply toilet paper.

Lol. I just had to jump in here. You really left yourself open here. In trading terms. You must have big poops (drawdowns) to need 5 ply. Also 5 ply must be expensive for a business (commissions?) or (big stop losses).

I mean no disrespect. Just being funny. I 100% get your point about testing with and without a stoploss. I believe I understand why as well. Correct me if I'm wrong.

You have to test without a stop loss as if your strategy gets an 44 percent win rate WITHOUT the stoploss how do you expect it to work with one.

On the other hand if you get a 80% winrate without a stoploss then you obviously have a profitable system. Then you add a catastrophic stop loss for emergencies.

I agree with you up to and until it goes passed testing. I think its a good exercise like examining your MFE/MAE.

But on the other hand if it works for you thats ALL THAT MATTERS!

Cheers

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  #64 (permalink)
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A thought:

The longer term the trades have, the higher the benefit / risk ratio should be, and vice versa.

There will be a trade length where the ratio will be 1/1, but this may be less.

For example; scalping, it seems logical to accept ratios less than one, as long as the reliability is high enough.

Another different thing is whether that relationship should be an operational objective or a measure of whether our operation is valid, whether it is worth it.

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  #65 (permalink)
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outlawx View Post
From what I seen from your post, I'll give you some of my insight. Starting from the beginning to the end. Trading futures especially NQ/RTY/ES/CL etc. Stop losses are strictly needed. A mental stop doesn't cut it, and especially since you have not tested this system on a LIVE account just a demo, they are two different ball games. Trading NQ without a stop loss especially with how volatile the markets are on a live account without much experience (sorry not trying to be mean just reality) is very dangerous. Now, we as retailers/majority of firms still cannot move Index prices in major ways. Looking at your 60-day backtest results, I would pick the stop loss one in a heart beat. Your Avg winning trade is $597 w/o Stop Loss, while your Avg losing trade is $2200 w/o Stop Loss. Your largest winning trade was $600 w/o Stop Loss and your largest losing trade was $6600 w/o Stop Loss. These are just some but very important red flags I noticed. Even tho you have more trades using a stop loss which makes it harder to compare to using no stop loss. Your avg winning trade was $595 with a stop loss. Your avg was $597 losing trade with a stop loss. Largest winning trade was $600 with a stop loss. Largest losing trade was $600 with a stop loss. Any average person looking at these two and comparing them can tell you trading with a stop loss is better. Using a stop loss gives you a base to your system, and then you work based around your stop loss. When I look at a trade placing my stop loss is the first thing I want to see, knowing where to place it defines the rest of the R/R makes me think is it worth it to take the trade or not. It will save you a TON of stress in the future to use stop losses. But if you can handle mental stops all the power to you.

I like your observation Outlawx. Looks like it would be the good start of a system starting with the latter, with stops, option.

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WoodyFox View Post
With all do respect....

"I didn't say that an optimal ratio doesn't exist. I'm saying the question doesn't make any mathematical sense"

So he agrees it could exist, but does not understand it mathematically...isn't that the point of the exercise?


On a side note.
There is 2 things going on in the thread. Some best market RR ratio and the ideal of trading without a stop to get a best RR ratio.

I agree on the no stop and having dangerous MAE.

But a good mean reversion strategy that is found with out stops can be made more desirable with lower risk of high MAEs Especially when dealing in a market with higher IV. There are ways to do this. Not full fixes, but certainly tradeable fixes.

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"But a good mean reversion strategy that is found with out stops can be made more desirable with lower risk of high MAEs Especially when dealing in a market with higher IV. There are ways to do this. Not full fixes, but certainly tradeable fixes."

...ABSOLUTELY AGREE. This is the exception as it makes sense... in a mean reverting market.

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  #67 (permalink)
Legendary Market Wizard
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Big Mike View Post
@Madness, just wanted to say I like your avatar

Agree. I was (am) going to say the same.


Madness View Post
So, before you can understand my stop loss you have to understand the meaning of my thread. The whole point to my thread is to be able to test a strategy without being unskewed by stop-losses that are usually triggered by market makers running stops.

If you subscribe to the market makers trigger stops school of thought, that's easy to avoid. Don't use conventional stop AMOUNTS. I'm sure there are a lot of stops 5 ticks, and/or $1000 and $2000 above and below the daily opening price. Nobody is looking for a stop $789 below the open!


Madness View Post
There are 4 requirements I need to classify a strategy successful. These requirements are:
1) Your strategy has to give you a 90% or higher win rate. Meaning it reaches the price target.
2) Your trade only lasts at most a few minutes. (1 sec to 20 min)
3) It has to give you consistent backtesting results under normal market conditions for 60 days.

Reduce a 'few minutes' to 'seconds' or even 'micro-seconds' and you are High Frequency Trader. I gather that's a decent business to be in.


WoodyFox View Post
But a good mean reversion strategy that is found with out stops can be made more desirable with lower risk of high MAEs Especially when dealing in a market with higher IV. There are ways to do this. Not full fixes, but certainly tradeable fixes.

+1. Definitely holds true for me.


Sandpaddict View Post
AKA... the longer you trade the larger the chance you'll see a larger drawdown then ever before. (Think LTCM) I think they STILL claim it couldn't happen in many many lifetimes)

While I do agree with your point I think LTCM is a bad example. Firstly a large chunk of their losses were due to 'strategy creep' but their complete collapse was a result of Wall Street feeding upon one of their own.

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  #68 (permalink)
Langley
 
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SMCJB View Post
While I do agree with your point I think LTCM is a bad example. Firstly a large chunk of their losses were due to 'strategy creep' but their complete collapse was a result of Wall Street feeding upon one of their own.

Agreed. That was a stretch. I think was trying to make a point but the point is ONLY that... the longer you trade the more likely you'll see a black swan event. And/or your largest drawdown.

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Market Wizard
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Hey @Sandpaddict

Yeah I can attest to the random entry theory. I used to do that to applicants that wanted to work on the trading desk.

You need both, entries and exits, to be really good over the long run. Maybe it could be said that the two items that are in your control are when you enter a trade and how much you will lose?
I say it often that risk is the number one consideration, meaning "first" thought and most vital.

Over your chosen time frame everything has a range to put in. What do I expect from this? Is it against trend or a reversal...then I'm out immediately if I'm wrong. Once I've achieved a reasonable piece of the anticipated range, do I want to press this trade and look one time frame up?

The fear/greed thing is something that most people get wrong, imo.

Let me know if you want more color.

-Dan

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Legendary Data Wizard!!!
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wldman View Post
Hey @Sandpaddict

Yeah I can attest to the random entry theory. I used to do that to applicants that wanted to work on the trading desk.

You need both, entries and exits, to be really good over the long run. Maybe it could be said that the two items that are in your control are when you enter a trade and how much you will lose?
I say it often that risk is the number one consideration, meaning "first" thought and most vital.

Over your chosen time frame everything has a range to put in. What do I expect from this? Is it against trend or a reversal...then I'm out immediately if I'm wrong. Once I've achieved a reasonable piece of the anticipated range, do I want to press this trade and look one time frame up?

The fear/greed thing is something that most people get wrong, imo.

Let me know if you want more color.

-Dan

@wldman

We could always use more color please!

BTW- Hope you start posting in your journal again. Invaluable information!

Robert

nosce te ipsum

You make your own opportunities in life.
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Madness View Post
Hello Adilius, Sorry for the really late response.

So, before you can understand my stop loss you have to understand the meaning of my thread. The whole point to my thread is to be able to test a strategy without being unskewed by stop-losses that are usually triggered by market makers running stops.

There are 4 requirements I need to classify a strategy successful. These requirements are:
1) Your strategy has to give you a 90% or higher win rate. Meaning it reaches the price target.
2) Your trade only lasts at most a few minutes. (1 sec to 20 min)
3) It has to give you consistent backtesting results under normal market conditions for 60 days.

Hello Madness,

Thanks for sharing.

Why only back test for 60 days and not years?

Thank you

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