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Finding the optimal R:R ratio for your trades

The risk/reward ratio (R:R) tells you how much you can earn for every unit of risk you are willing to take on a trading setup. That means, that if you have an R:R of 1:3, you can make 3 dollars for every 1 dollar you are risking. In order to find the optimal ratio, you will have to do a deep dive into your trading strategy. Let’s start!

First, there are two ways a target and R:R can be set. A target can be set based on the next area of interest, such as a level or zone. Using this method your R:R will vary for each trade but will bring you more in tune with the market’s moves. The other method of setting targets is based on a fixed R:R for every trade setup such as 3:1. This method requires more testing and thorough analyses of the statistics of the strategy. It ignores any technical barriers that may lie ahead when you position yourself in a trade.

The answer to your optimal R:R can only be found through testing, testing, and more testing. Whatever method you decide to apply, you need to gather data for different options to approach your R:R. While you are testing make sure to log results for different R:R’s to choose the best once you are done. The same applies to the targets based on levels/zones, make sure to record how your positions react to each type of zone/level it encounters to figure out where to best place your targets.

In order to analyze the data you collected you have to take into consideration the following factors:

The strike rate for each target option. You will have to find the optimal balance between Strike Rate and R:R, which are inversely correlated. Strike Rate identifies the amount of winning trades out of the total number of trades. A low strike rate also implies a higher losing streak statistically. A high R:R might give higher overall returns but could also lead to a maximum losing streak that becomes unbearable for the mind because fewer trades hit your target.

Average return per trade & amount of trades per period. Average return per trade or trade expectancy are metrics used to identify the average outcome each time you press buy or sell. However, this only makes sense if you have a large enough sample size of trades per period.

Personal preference. Analyze your plan, write down a few options for R:R setting and analyze the outcomes. The most statistically rewarding R:R setting doesn’t always have to be the way to go if it doesn’t reside with you. If you prefer being in & out of the markets quickly, you might have to settle for a lower R:R that might not be statistically optimal. However, if this means that you will be able to stick to your plan better and are in a better place mentally, then go for that option.

Your hard work will pay off, keep it going!

Speak to you soon!

Kind regards, Joost

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