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Reward-Risk Ratio

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Reward-Risk Ratio

Reward-Risk Ratio (RRR) is an essential and fundamental component of  Order-Management Strategy. The purpose of RRR is to pinpoint and validate the financial instrument prices for the most profitable trading opportunities. For ease of understanding, Money Printing Strategy uses "Reward-Risk" Ratio and not "Risk-Reward" Ratio: It is easier to compare positive numbers than fractions. The higher the value of RRR, the more fruitful the trade would be. The RRR main contribution to Trading-Checklist is provision of a "go" or "no-go" signal before placing any order. It verifies that potential gains relative to potential losses is high enough to justify placing of orders. Furthermore, it forces usage of support and resistance trend lines for opening and closing of positions. Finally, it minimizes the costly risk of over-trading by signaling "no-go" for risky trades. Before determining the Reward-Risk Ratio, it is necessary to accurately predict the market ongoing trends. It is done by applying the Trend-Prediction Strategy (TPS). Application of TPS is a prerequisite for calculation of RRR.

For the sake of good understanding of the RRR concept, let us take a theoretical example. We assume that the market is within a horizontal channel with support at 100 and resistance, at 120. This results in a channel range of 20 points. Here we empirically assume that if the wave goes 2 points below the support level of 100 or 2 points above the resistance level of 120, the market contradicts the originally predicted trends.

The process to calculate the value of RRR for a Long position would be as follows:
  1. The trade Open price would be $100.
  2. The trade Close price would be $120.
  3. Total potential gains would be $20 per share or 20 percent of invested capital.
  4. The Stop-Loss would be at 98 (100 - 2). The total potential loss per share would be 2 points or 2 percent of invested capital.
  5. With this example, the RRR value is calculated by dividing the trade potential gains (20) by potential losses (2), hence resulting in a RRR value of 10.
It is essential to understand that while prices fluctuate within the channel between 100 and 120, the RRR value varies significantly. For example, when the price is at 105, the RRR would shrink drstically and becomes 2.5 ((120 - 105 = 15) / (105 - 98 = 7)) and therefore, the Trading-Check list would signal a no-go for the trade. This is because while the amount of potential gains decreases to 15 (120 - 105 = 15), the amount of risks rises simultaneously from 2 to 7 (105 - 98 = 7). If we were to open a Long position at $115, the Reward-Risk Ratio would become less than 0.3 ((120 - 115 = 5) / (115 - 198 = 17)). This signifies a more than three times potential risks than potential gains. Therefore, the RRR would signal a clear "no-go" for the trade. Money Printing Strategy is a gaining strategy because it considers opening and closing positions at the support or resistance levels where the RRR value is maximal. The so-called "Random Walk" theory that recommends opening of Long positions at any time is a losing strategy because the position can be opened at times, mostly when indeed the level of potential risk may outweigh several times the level of potential gains. This theory is usually not recommended by  professional financial advisors who have in mind the interests of their clients. However, it is aggressively promoted by an overwhelming number of financial advisors and brokers out there who live from the income generated from the commission of business with their clients, rather than from the gains in trading portfolios. Such professionals do usually lose also their own investing money too. One of the main reason why the investing crowd loses money is because they blindly follow the wrong recommendations based on the "Random Walk" theory, which is like trying to watch the sunset but facing towards the east.

Based on this example, it would be understandable that with an RRR of 10, even if 90 percent of trades are losing (9 out of 10) and only 10 percent gaining (1 out of 10), the portfolio would not lose a penny, except the broker commissions.

By applying the Money Printing Strategy in a very basic way, an average of 75 percent gaining, and 25 percent losing trades should conservatively be achievable. This is possible thanks to the highly sophisticated and reliable Trend-Prediction Strategy and Order-Management Strategy. This rate should rise to over 90 percent if applied correctly and using real-time market charts.

By achieving an average ratio of 75 percent gaining (3 out of 4) and a 25 percent losing trades (1 out of 4), and by assuming an RRR of 10, the trading results after ten trades should yield the following results:
  1. Each gaining trade yields a 20 percent gain or, with 1,000 shares per trade, a $20,000 Gain. This example assumes a trading capital of $100,000.
  2. Each losing trade would represent a loss of $2,000 or 2 percent.
  3. Assuming an average of 75 percent gaining (3 out of 4) and 25 percent losing trades, the profit-loss figures would be as follows:
  4. Each of the 7.5 gaining trades, gains $20,000, resulting in a total gain of US$ 150,000. The 2.5 losing trades, lose each $2,000 or a total loss of $5,000. The balance would be 150,000 – 5,000 = $145,000.
  5. Consequently, each of the ten trades, gains in average $14,500 whether gaining or losing.
  6. Even if only 10 percent of trades would be gaining and 90 percent losing, we would still be even.
The assumptions of 75 percent gaining trades and the RRR of 10 are rather conservative expectations. The second round of demo-trading yielded a ratio of 97% gaining and only 3% losing trades while trading using real-time charts. Out of 66 trades, 64 were gaining and only 2, losing.

You may recall that Money Printing Strategy uses the specifically designed Loss-Parking Strategy to minimize losses, and seldom the customary stop-loss strategy.
The TradeAlert Newsletter Performances have meanwhile demonstrated a ratio of over 80% gaining and less than 20% losing trades despite the heavy constraints of using end-of day charts. If you are not interested in learning the Money Printing Strategy but still want to make money by trading or investing, you may consider subscribing to this service.
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