Taking your game from weekend hack to working pro with risk/reward ratios
137 yards of pure terror. Otherwise known as the par three 17th at TPC Sawgrass. Coming down the stretch, many a pro has lost their mind trying to make something happen – only to dump it into the water – leaving hundreds of thousands of dollars on the table.
Every day, millions of Forex traders go for broke, trying to make something happen in their respective market. Whether it’s to make up for lost ground, or to pad profits – the outcome is usually the same: wipeout.
Using a basic risk/reward ratio, retail traders can save their accounts from catastrophic calamities that can befall any trade. This will keep your account alive to fight another day, while separating you from other retail traders struggling to break even.
An account killer traders tee up every day
There have been only 7 hole-in-ones at Sawgrass’ par 3 17. If you’re a pro, your odds are 2,500 to 1. You don’t want to know what the odds are for amateurs. Ask a pro if they ever think about hitting a hole in one during a tournament – and they’ll tell you it’s the last thing on their mind.
Yet, this is exactly what millions of Forex traders do every day. They step up to the market’s tee box, club (entry) in hand – expecting to hit an ace. This happens because they overlook their primary job when entering a trade: risk management.
Why? The prospect of profits is simply too enticing for many. This focus on profits is only further compounded by an industry glutted with get-rich-quick schemes and gadgets. Your inbox is likely filling with these very offers as you read this.
In reality, it’s an account killer.
Why focusing on profits leads you to losses
Golfers who’ve lowered their handicap to single digits will reveal one truth most amateur golfers find impossible to believe: it makes no difference what clubs you use. It’s knowing when to play it safe and when to let it rip on a golf course that will melt strokes off your score.
Most retail traders hold the belief that they can head to the market with a trusty widget and a heart filled with hope – and they’ll be rich in no time. Talking about anything other than profits is seen as limiting and unfulfilling.
Like an amateur golfer who can’t get his score below 90 – retail traders will continue to rack up losses unless they embrace risk. This is because unbalanced focus on profits enables the lack of discipline and process that forever keeps them out of reach.
Over-trading, increased position sizes and over-exposure for losing positions are all activities fueled by the pursuit of profits. And they are exactly what turns manageable losses into account-clearing events.
Fortunately, there is a simple practice you can employ immediately to help turn this around.
Close the gap with a simple question
On a Sunday afternoon, as any major closes out you’ll hear commentators talking about risk and reward. Decisions about club selection, distance and placement suddenly have hundreds of thousands of dollars riding on them – if not millions. The ones who play it safe are generally the ones that finish at the top of the leader board – with bank accounts to show for it.
The same is true with trading. A simple risk/reward analysis can be conducted with every trade. It starts with one basic question: What’s one dollar worth to you? It’s followed by a second question: What are you willing to risk to get it?
The result comes down to a ratio that can be translated directly to your chart. Say your risk/reward is 1:1. You’re willing to risk – or lose – 10 pips to make 10. Reasonable enough if you’re a scalp trader.
Enter this into ATM (Advanced Trade Management) using NinjaTrader’s Chart Trader. The second your entry is filled – a corresponding stop and target will appear on your chart.
In an instant, this forces two incredibly important factors that 90% of retail traders unknowingly bypass:
- Catastrophic Loss Protection: By having a stop automatically applied, your account will be protected should the currency pair’s rate spike against you. This happens every day, usually due to news – and clears most traders out.
- Stop Management: The ability to advance your stop to lock in profits helps you reduce risk the longer your trade’s in play. If you’re thinking about pushing your stop back – which you shouldn’t – it forces you to answer why.
Adhering to this practice will help you preserve your capital. If you’re a beginner or intermediate trader – this is critical while you learn to make entries and exits that are consistently profitable.
It will also force you to see your trades as the professionals do – while eliminating the account-clearing losses.
Trading to keep YOUR account open, not the pros
After hitting his famous pine straw shot out of the trees at The Masters, Phil (‘the thrill’) Mickelson famously said: ‘It was actually a lot scarier in person. The gap in the trees was much smaller than it looks like on TV.’ He hit that shot within four feet of the pin and would go on to win his third green jacket.
Clearly his risk vs. reward calculation is different than most. Likewise, using a risk/reward calculation that doesn’t suit the amount of available capital in your account, or your proficiency as a trader, will do you no good.
As a scalper, your risk/reward really shouldn’t be any more than 1:2 given the short periods of time you’re in the market. If you’re a swing trader a risk/reward of 1:3 may be more appropriate given the limited number of trades you’ll be taking and the larger exits you’ll be targeting.
If you can’t make a logical case as to how your risk/reward ties to your trading strategy, do what a struggling golfer would do: talk to a pro. The number of trades you take, your time in market – and your profit/loss targets should all tie together. If one is disproportionate – for instance, your risk/reward is 1:3 but you take 20 trades a day – your results will fall short of expectations.
Whatever you do, don’t attempt a Phil ‘the thrill’ risk/reward ratio if your account and experience can’t back it up.
Add risk/reward to your bag and profit like the pros
Among the notable meltdowns at TPC on a Sunday afternoon, Len Mattiace carded a quintuple-bogey 8. The timing couldn’t have been worse, he was only one shot back going into 17. Thanks to a sucker pin, usually found on Sundays – his first shot ended up in the water.
Going for broke is usually a great way to end up being broke. Add risk/reward to your back as a permanent fixture. Like a trusted caddy that tells you to play it safe during crunch time – keep this as your guide.
Choose a ratio that suits your real trading strategy and capital base. If you’re a scalper, keep it small – 1:1 or 1:2. Should you plan to genuinely swing – plot a more generous ratio at 1:3 to 1:4. Bring these ratios directly to your chart with ATM.
Answer the age-old question regarding risk: What’s one dollar worth to you? Then swing your entries with a smooth confidence, knowing that you’ve protected yourself from catastrophic TPC-like failure.