“Risk for Reward” is our key focus. Part 1.

“Risk with 1 to gain 10” is our the best performance formula

It is all about simple math: to be consistently stable at trading in financial markets and especially Forex we should focus on Risk/Reward ratio of entire trading system. It is one of the most important keys.

Basics about R/R ratio you can find in Investopedia or many other financial websites, but here we will focus about most important details.

Any trading system or robot to be taken under consideration for usage on live account should have minimum Risk Reward ratio 1 to 6 in past couple years. This is our minimum requirement. If there are any robots that gives in backtests R/R ratio equal to 5.99, sorry, not good enough even to start.

Obviously, we should and do look all the time for higher R/R ratio, ideal would be to reach 1:100 🙂 And sooner or later we will get it, it’s only question of time, but for now we work with 1:6 as minimum.

Why?

The idea behind this is simple, we should risk less to earn more: this is the only way to have confidence that the system in the end of the day will give us profit, not losses.

For example, let’s take some of the most popular robots from Mql5 marketplace and evaluate them.

 

 

LCF Theta Vector

Let’s see our backtested results:

EURUSD default settings fix lot = 0.01

In 2 years we had maximum floating drawdown 303.25$ and total earnings of 912.78$. Which means we risked 303.25 to earn 912.78, R/R ratio = 912.78/303.25 = 3.01

Would you use this robot?

Some might say: sure, it’s ok, anyway in the end I got profit. Yes, you did, but you were waiting for it too long, weren’t you?!

Maybe we should do some homework (correct optimizations, more backtests and etc) and find better settings for same currency pair like this:

EURUSD optimized settings fix lot = 0.1

In 2 years we had maximum floating drawdown 1 440.45$ and total earnings of 6 812.83$. Which means we risked (if using same 0.01 fix lot like with default set) with 144.05 to earn 681.28, R/R ratio = 681.28/144.05 = 4.73

So which set file is better to use? For sure, the optimized.

But, as we can see the R/R ratio is lower than 6.0 (minimum requirement as we agreed in the beginning), so should we forget about the bot?

We should if this particular EA doesn’t provide any option to trade with other currency pairs or timeframes and to build combined portfolio with desired Risk to Reward ratio.

Let’s do more homework and find better settings by optimizing different timeframes and currency pairs:

USDJPY optimized settings fix lot = 0.1

Risk to Reward = 10.20

 

XAUUSD (Gold) optimized settings fix lot = 0.1

Risk to Reward = 7.05

And now let’s combine these 3 trading systems together:

NB! Drawdown in Quant Analyzer are calculated only by closed trades, so if we would compare it with floating drawdown for each pair we can find it is lower for 17,5-22% usually.

 

Let’s summarize with this adjustment. Currently our portfolio has following performance:

  • Maximum ever seen floating drawdown: 1 901.22$
  • Total earnings: 33 786.18$
  • Risk to Reward ratio total: 17.77
  • Risk to Reward ratio monthly: 0.71

What conclusion we have? Risk to Reward is 17.77, that is good enough to go live. Also now we have monthly R/R ratio, which is 0.71. What does it means?

It means, if today we launch the system on live account and somehow we are so lucky to go in drawdown and losses next day (forex is the forex, risks are involved in any given moment), we will need just 1-2 months to recover from losses and start to earn.

Same time, if the trading will go smooth from first trade and next 30 days we will gain forecasted +/- 1 351.45$ and next months again +/- 1 351.45$, then our total income will be 2 702.90$ in two months. And here let’s assume that on month three system will perform with some drawdown equal to the maximum one ever seen 1 901.22$. And how do you feel now? Summary we are in the profit zone, so no need to panic and curse the market, robot and etc. With calm and patience (it’s easy when you are in the profit zone) just leave the robot for the following 1-2 months and proceed to see how your assets keep growing.

That’s why Risk to Reward ratio is so important: it not only gives you more opportunities for profit, but what is more important it gives you privilege to grow your assets with less stress and with more confidence without “sitting under the water ” (stay in losses) for months, quarters or even years.

 

Let’s do experimental evaluation with other robot from top, for example…. to be continued in next posts.