Case Study – Random Entry & Risk Reward in Forex Trading
A Case Study of Random Entry & Risk Reward
Over
the last two weeks I have conducted a trading experiment in order to
prove a point to anyone out there who might be in doubt of the power of
risk reward combined with price action trading strategies. This article
will take you on a journey into my mind and will hopefully prove to you
that if you simply implement proper risk reward and have a willingness
to learn a high probability trading strategy like price action, you have
all the ingredients to become a consistently profitable forex trader.
This article will open your eyes, I suggest you read it, start to learn
about the concepts discussed.
The experiment:
In order to first demonstrate and prove the power of risk reward, I decided to randomly enter 20 trades over the last 2 weeks in the EURUSD, GBPUSD, and AUDUSD on a demo account. No price action setups were used, nor was there any method or strategy of any kind implemented when entering the market. The parameters were simply to enter one of the above three currency pairs a total of 20 times within 10 trading days using a stop loss of 50 pips and a target of 100 pips for each trade, making a risk reward of 1 to 2 on every setup. I did not “mess” with any trade once it was entered, I employed pure set and forget forex trading in this experiment; I simply entered and then let the market do its thing, in order to prove the power of risk reward. (Note, the 20th trade was at breakeven at the time of this writing and I did not have time to wait for it to close out, I counted it as a winner, I will update this article if it ends up becoming a loser when it closes, although this will not change any of the implications or insights of this article.)
While this experiment was meant to prove the power of risk reward, it was also meant to prove the power of price action trading strategies combined with risk reward. My results showed a small profit after entering randomly 20 times with a risk reward of 1 to 2 on every trade, this after having lost 12 out of 20 trades. This means my winning percentage for this series of trades was 40%, so I lost on 60% of the trades and won on only 40% as you can see by the trade history below , this random entry model combined with a 1 to 2 risk reward still profited about $200, this with no edge applied at all.
What is the lesson to learn here?
While the trade history above certainly proves the true power of risk reward, we have to ask ourselves how much better we could do by applying a true edge in the market, like the edge we get from trading price action setups. When combined with experience and education, price action trading strategies can certainly provide you with trade setups that give you a better than 50% probability in the market, assuming you apply discretion and do not over-trade. So, if we assume we can attain at least a 50% win rate by using simple price action strategies like the ones that I teach, and we use a risk reward of at least 1 to 2 on every trade, over a series of 20 trades where we risk $50 per trade, we would make a profit of $500 ($1000 in winnings – $500 in losses).
So, we know that risk reward strategies work, there is no doubt about that at all; you randomly enter the market and if you make at least 2 times your risk on your winning trades, you will likely breakeven or turn a small profit over a series of trades. When we combine this knowledge of the power of risk to reward with a high-probability edge like price action, what we have is a professional money management and trading strategy, which when combined with the proper education and discretion will make money over a series of at least 20 trades or more.
Professional traders know that their winners have to out-pace their losers to make money, because most professional traders only win about 50% of the time. If you have no edge in the market that can get you to the point of winning at least around 50% of your trades, you are probably going to only breakeven over any series of trades, assuming you still implement a risk reward of at least 1 to 2. Most traders do not implement risk reward properly; they take profits of less than 2 times risk which inherently forces them to have a very high overall winning percentage to make money. By taking a profit of less than 2 times risk, you are basically PURPOSESLY putting the odds against you, because you then will have to win over 50% of your trades to make money, and most trading strategies do not give you an edge that will allow you to consistently win over 50% of your trades.
A high quality price action setup allows you to set and forget your trading while still giving you a higher than 50% chance of winning any given setup. What this means is that with price action and risk reward you have a nearly stress-free way to trade the market; you can wait patiently for obvious price action setups that develop from confluent areas and/or in trending markets, enter a risk reward of 1 to 2, and walk away until the trade is closed. If you actually do this with discipline, by only taking obvious price action setups and rigidly implementing a risk reward of at last 1 to 2, you will become profitable over a series of trades.
The key is to not get discouraged if you hit a few losers or become over-confident if you hit a few winners. What if you lose on the first 8 trades out of 20? Look at the results of my trading experiment above; did you notice that I lost on 9 trades in a row before hitting a series of winners? This is called trading, and sometimes you will hit a string of losers or a string of winners, but you can’t let this influence your forex trading plan, you have to have a longer-term outlook and remind yourself that your edge, combined with risk reward, needs time to play out.
Obtaining the proper training is the key.
Other
than being able to control your emotions and remaining disciplined
enough on a consistent basis to not over-leverage or over-trade and
implement proper risk reward on every trade, the biggest variable that
can influence your trading success is whether or not you know what your
edge is and when you should trade it. This is where proper forex trading
education on a high-probability trading strategy like price action
comes in. I have been successfully using simple yet effective price
action setups to trade the markets now for years, and I teach other
traders exactly how I trade in my forex trading course. My course and
it’s teachings not only give you a trading strategy, but it shows you
when to use the strategy and what the market should look like before you
enter.
When you combine my price action setups with a thorough knowledge of risk reward implementation and a mastery of trading plain vanilla price charts, you will begin to think like a professional trader. Pro traders see the market in a completely different way than amateurs do; they do not over complicate anything. First they check the market to see if their trading edge is present; if it is not present then they leave the computer or not look at the charts for a period of time, typically at least 4 hours. If their trading edge is present, they will then move on to the next factor to check; whether or not a risk reward of at least 1 to 2 is logically attainable. If a risk reward of 1 to 2 is attainable then they enter the trade and walk away, that’s it. The reason a professional trader thinks and trades like this is because they don’t get attached to any one trade; they know that each trade is just one out of a series of many that they must take in order to see their edge play out. Amateur traders get caught up on each trade; they react to the emotion of each loser or winner because they simply cannot see the forest for the trees, typically due to a lack of experience and insight.
My trading course and price action trader’s community gives you the insight you need to become a successful discretionary price action trader, the experience is something you must develop on your own from the tools and education that I provide. When you combine the price action and risk reward strategies that I teach with a healthy dose of self-discipline and trading experience, there is virtually nothing that can stand in your way except your own lack of self-control. If you would like to learn more about how I trade the market with price action setups and risk reward scenarios, please check out my price action forex trading course.
Over
the last two weeks I have conducted a trading experiment in order to
prove a point to anyone out there who might be in doubt of the power of
risk reward combined with price action trading strategies. This article
will take you on a journey into my mind and will hopefully prove to you
that if you simply implement proper risk reward and have a willingness
to learn a high probability trading strategy like price action, you have
all the ingredients to become a consistently profitable forex trader.
This article will open your eyes, I suggest you read it, start to learn
about the concepts discussed.The experiment:
In order to first demonstrate and prove the power of risk reward, I decided to randomly enter 20 trades over the last 2 weeks in the EURUSD, GBPUSD, and AUDUSD on a demo account. No price action setups were used, nor was there any method or strategy of any kind implemented when entering the market. The parameters were simply to enter one of the above three currency pairs a total of 20 times within 10 trading days using a stop loss of 50 pips and a target of 100 pips for each trade, making a risk reward of 1 to 2 on every setup. I did not “mess” with any trade once it was entered, I employed pure set and forget forex trading in this experiment; I simply entered and then let the market do its thing, in order to prove the power of risk reward. (Note, the 20th trade was at breakeven at the time of this writing and I did not have time to wait for it to close out, I counted it as a winner, I will update this article if it ends up becoming a loser when it closes, although this will not change any of the implications or insights of this article.)
While this experiment was meant to prove the power of risk reward, it was also meant to prove the power of price action trading strategies combined with risk reward. My results showed a small profit after entering randomly 20 times with a risk reward of 1 to 2 on every trade, this after having lost 12 out of 20 trades. This means my winning percentage for this series of trades was 40%, so I lost on 60% of the trades and won on only 40% as you can see by the trade history below , this random entry model combined with a 1 to 2 risk reward still profited about $200, this with no edge applied at all.
What is the lesson to learn here?While the trade history above certainly proves the true power of risk reward, we have to ask ourselves how much better we could do by applying a true edge in the market, like the edge we get from trading price action setups. When combined with experience and education, price action trading strategies can certainly provide you with trade setups that give you a better than 50% probability in the market, assuming you apply discretion and do not over-trade. So, if we assume we can attain at least a 50% win rate by using simple price action strategies like the ones that I teach, and we use a risk reward of at least 1 to 2 on every trade, over a series of 20 trades where we risk $50 per trade, we would make a profit of $500 ($1000 in winnings – $500 in losses).
So, we know that risk reward strategies work, there is no doubt about that at all; you randomly enter the market and if you make at least 2 times your risk on your winning trades, you will likely breakeven or turn a small profit over a series of trades. When we combine this knowledge of the power of risk to reward with a high-probability edge like price action, what we have is a professional money management and trading strategy, which when combined with the proper education and discretion will make money over a series of at least 20 trades or more.
Professional traders know that their winners have to out-pace their losers to make money, because most professional traders only win about 50% of the time. If you have no edge in the market that can get you to the point of winning at least around 50% of your trades, you are probably going to only breakeven over any series of trades, assuming you still implement a risk reward of at least 1 to 2. Most traders do not implement risk reward properly; they take profits of less than 2 times risk which inherently forces them to have a very high overall winning percentage to make money. By taking a profit of less than 2 times risk, you are basically PURPOSESLY putting the odds against you, because you then will have to win over 50% of your trades to make money, and most trading strategies do not give you an edge that will allow you to consistently win over 50% of your trades.
A high quality price action setup allows you to set and forget your trading while still giving you a higher than 50% chance of winning any given setup. What this means is that with price action and risk reward you have a nearly stress-free way to trade the market; you can wait patiently for obvious price action setups that develop from confluent areas and/or in trending markets, enter a risk reward of 1 to 2, and walk away until the trade is closed. If you actually do this with discipline, by only taking obvious price action setups and rigidly implementing a risk reward of at last 1 to 2, you will become profitable over a series of trades.
The key is to not get discouraged if you hit a few losers or become over-confident if you hit a few winners. What if you lose on the first 8 trades out of 20? Look at the results of my trading experiment above; did you notice that I lost on 9 trades in a row before hitting a series of winners? This is called trading, and sometimes you will hit a string of losers or a string of winners, but you can’t let this influence your forex trading plan, you have to have a longer-term outlook and remind yourself that your edge, combined with risk reward, needs time to play out.
Obtaining the proper training is the key.
Other
than being able to control your emotions and remaining disciplined
enough on a consistent basis to not over-leverage or over-trade and
implement proper risk reward on every trade, the biggest variable that
can influence your trading success is whether or not you know what your
edge is and when you should trade it. This is where proper forex trading
education on a high-probability trading strategy like price action
comes in. I have been successfully using simple yet effective price
action setups to trade the markets now for years, and I teach other
traders exactly how I trade in my forex trading course. My course and
it’s teachings not only give you a trading strategy, but it shows you
when to use the strategy and what the market should look like before you
enter.When you combine my price action setups with a thorough knowledge of risk reward implementation and a mastery of trading plain vanilla price charts, you will begin to think like a professional trader. Pro traders see the market in a completely different way than amateurs do; they do not over complicate anything. First they check the market to see if their trading edge is present; if it is not present then they leave the computer or not look at the charts for a period of time, typically at least 4 hours. If their trading edge is present, they will then move on to the next factor to check; whether or not a risk reward of at least 1 to 2 is logically attainable. If a risk reward of 1 to 2 is attainable then they enter the trade and walk away, that’s it. The reason a professional trader thinks and trades like this is because they don’t get attached to any one trade; they know that each trade is just one out of a series of many that they must take in order to see their edge play out. Amateur traders get caught up on each trade; they react to the emotion of each loser or winner because they simply cannot see the forest for the trees, typically due to a lack of experience and insight.
My trading course and price action trader’s community gives you the insight you need to become a successful discretionary price action trader, the experience is something you must develop on your own from the tools and education that I provide. When you combine the price action and risk reward strategies that I teach with a healthy dose of self-discipline and trading experience, there is virtually nothing that can stand in your way except your own lack of self-control. If you would like to learn more about how I trade the market with price action setups and risk reward scenarios, please check out my price action forex trading course.
Generally :-( The risk to reward should reflect the type of strategy you are using. A breakout type strategy would have a better risk to reward but lower win percentages. Reversal generally has a better win but less less risk to reward. Also I agree with entry exit with more emphasis on exit. Lots of people talk about entry but with out good exit it will make no big difference. An exmple of this would be conners 2 period RSI. A set stop gives you poor results. ATR is a little better, combined with a moving average it increases significantly, you could try a trail of some sort. The point is the exit is as important to the entry. Static set stoplosses in my opinion are open to whipsawing. But just because I cant get it to work doesnt mean it doesnt.
Keep in mind I never really like to make HARD rules about the market these are generalisations, I find what maynot have worked in the past given my new found experience knowledge will often work in the future. Its the systems wholistic conbinations that make it a better system.
The only component that can be computed is how much you are willing to lose on a trade. Even then you could get a gap that will skew that number as well.
Risk/Reward can only be computed after the trade.
Far more important than entry are your exits, your position sizing and following your system.
60% psycology , 30 % money management and strategy is just 10% on ur success
I’m afraid that you have fallen into one of the traps in statistical thinking that catch out many unwary traders.
In a market with random entries, setting a 2:1 risk reward (or any other ratio) will result in zero profit, less the cost of trades when tested over a large number of trades. This is because the probability of price hitting the stop is inversly proportional to the distance of the stop from the entry point. Also 20 tests are not neary enough to give your test any sort of statistical validity. At least a few hundred tests would typically be required.
The fact that you obtained a small profit from this test is purely luck. It could have just as easily ended in a lost.
What you correctly say is that it is the edge, due to your high probability entry that determines the outcome. It is also this edge that enables you to take advantage of a risk return ratio of 2:1 or whatever.
Random entry on its own won’t work if you test it over a sufficiently large number of trades. In other words there is no intrinsic edge in how you sets your stops.
God bless.
This is the PIVOT in trading that every other wheel revolves upon.
Thank you my ‘prof’.
There is one point that needs to be asked when taking it from scientific approach as should be: I think it is safe to say that higher Risk-reward will result lower SR and vice-versa, reducing the RR will increase the SR.
Have you looked at such optimization? Did you try working your PA strategy on different combinations for example risk-reward of 1:1? or 3:1?
Is 2:1 is the ratio that you recommend for your PA strategy?
Thanks again for a great article and the desire to help others.
thanks, keep up the good work!
Thanks a bunch.
All the best and thanks for your tutorials, Max
Best wishes David
Appreciate very much for the educational articles especially risk reward. Thanks very much.
I would say this is the best article you have ever
written and is exactly what I needed to understand.
Instead of getting hung up on each trade individually
I need to evaluate many trades over time. I always talk myself out of trades not wanting to lose but I need to take all the valid trades and let the risk reward work out.
Thanks
Carl
I really enjoyed writing this article., so I am glad you liked it.
I know many members who have used the concepts of risk reward etc, to turn there trading around, I really think this is important. Risk reward and sticking to the trade is the key.
Your article always inspire me alot!! Thank you for writing these good articles.
lot of love for you and family
Thanks
John
Thanks for sharing results of your experiment. Rather clear and to the point. Risk/Reward plus all your previous advice have given me opportunities from the ground up to become a successful trader. I enjoy each article.
Your student
I have followed your articles & instructions for quite a while now, but just that I am not quite too good at commenting. I am now compelled to comment for two reasons; most importnantly is to give my heart out to the nice and loving people of Australia, to tell them that we feel what they are going through at the moment. We love you & and we are praying for you. The current global events: i.e, natural fury, violence, man’s inhumanity to man, waves of killings, and terrorism, all these called for the wise christians to turn back to their first love-God,Bible to seek for answers & refuge.God loves you, and you will all come out of this stronger Amen.
The second reason is to thank you so much Nial for your love, support & free sacrifice to humanity. I have’nt met you in person but I can feel you, &,am almost certain that you are soft and kind person.
Hope to see more of me soon.
Thanks you so much Nial & I wish you the very best in Life.
From Nigeria
great experiment, very powerful example of risk to reward scenario, I have actually seen a similar experiment done before and surprisingly the results were practically the same, so i guess it just goes to show that if you cut your loses short and let your profits run longer that system in it self will keep your account in good health, add to this the edge of price action and it can’t be clearer
”a winning combination”..
I must say that since i have been applying your price action method to my trading it just gets better week in week out… nice one mate, best regards…
Many thanks for all your helpand God bless you
My point is how to do in the case of high/big SL?
. Sorry for your people having difficulties.
Thanks also for very good article
Wendy
Qld Australia
My best wishes for you and your people in this difficult times in Australia.
God Bless
Tommy
well done
Very productive lesson on risk reward and how PA can make it work in our favor.
Hope the floods end soon.
I will also be joining soon
Still, a very useful article. Thanks man. Big up yuh self Nial.
With regards to this invaluable lesson, as a member I appreciate your ongoing support and lessons, as well as the clear and concise (KISS) principals you apply.
Anyone still in doubt about joining this community, THIS IS THE REAL DEAL.
Keep up the good work Niall!!
will be joining soon
just getting my financing together
thanks
Thanks!
It gives me even more enthusiasm to do some experimenting along the lines of your 20 trades with at first no PA signals, then another 20 with any PA signals – even weak ones – and finally another 20 with only quality PA signals as a condition of entry. All on demo account, of course.
Your lesson also encourages me to be even more disciplined with my real account order entries (and exits!)
I love your intelligent, yet not overly complicated approach to Forex itself and Forex lessons. Please keep the lessons coming!
Mick O.
Thanks again nial.
Looking forward to more of your words of wisdom!