By Doug West
I’ve never been a big fan of Risk-To-Reward ratios. There are a million ways to calculate them for one thing. It is simple to say that you want a 2 to 1, or a 3 to 1, or a 4 to 1 ratio, but where do you start, and where do you get out of the trade? Do you base that on someone’s pivot points (another trading aid that has MANY formulas), or some other formula?
The problem I have with Risk TO Reward ratios is that I have seen them cause traders to hold trades too long. I am a firm believer in taking profit when the market makes it available to you. If you don’t, you can let a profitable trade become a loss. I’ve seen this happen time and again when someone is putting too much weight on some magic ratio.
I do see the attraction with these ratios. If you can get a 2 to 1 risk to reward ratio, you can actually lose over half your trades (if you make sure your losses are 1/2 the size of your winners), and still come out on top! Sounds great in theory, but in live action I find much harder to accomplish.
The problem is that you NEVER know what the market is going to do next, I don’t care how many formulas you go by, or how many indicators you look at! Those indicators are all based on formulas too.
Here is another problem, whose formula do you go by? Ted’s, Jed’s, Ed’s, or Fred’s formula? There are a TON of them to choose from.
In the long run I have found that you will do a LOT better by just taking what the market gives you, and cutting your losers short. If you do that consistently, you will be way ahead of those who look to some arbitrary ratio on their trades. They may work for longer term investments, but with day trading I like to stay in the moment and take what the market is offering. OH, I see my set up coming, I’ve got to go!
Doug West has worked in Financial Planning and Investment training for over 20 years. Get his No-Cost Audio Report on how you can Secure Your Retirement with Free-Online Tools:
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