Last post explored how a trader can evaluate his edge by implementing an analysis methodology and routine. I talked about the importance of having a large winner vs loser ratio both in profits and frequency. In other words a good Reward:Risk ratio in your trades.
Regardless of the buy or sale signals that a trading system generates a trader should look at what price the trade is considered a failed attempt. That price is where the stop-loss should be placed and the trade exited for a small loss. Likewise, a trader should look at a profit target where a sale (or cover) order will be executed. If you follow the 3:1 rule for a potential profit vs. potential loss, then you can determine if it makes sense to enter the trade.
This type of analysis should be done before even figuring out the size to trade. Use the following formula to determine the R/R:
(Target – Entry) / (Entry – Stop) for a long position.
(Entry – Target) / (Stop – Entry) for a short position.
I have programmed a calculator in the Stock Trade Journal application as well as the new StockTradeCalc for the iPhone to make it easier. Simply enter the prices in the given fields and press the calculate button to get the R/R for the trade. Of course you can use excel or a hand calculator as well.
[...] trading Managing risk in trading is all about keeping losses small and your winners big. In the previous post I talked about how to calculate Reward : Risk in a trade and that the aim is to only enter [...]
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