SanDiegoMagaPede Trading Plan Lesson 3: Risk and Reward ... The "Holy Grail" of Trading

#Lesson 3: Risk and Reward

As mentioned in my 1st post, many people spend a lot of money and waste a lot of time trying to look for the mythical holy grail of Forex trading. Generally this holy grail is believed to be a system or robot which is 100% accurate or near 100% accurate and is a super duper ultra secret only known by a few on "the inside". If you were able to discover the secrets of this "holy grail" you would be set up for life theorectically.

Well as I said before this holy grail does not exist. There is no super secret method of trading that can get you 100% accuracy in the market. However if you change the WHERE you look you will realize that the holy grail of trading was right next to you the whole time.

#People think the holy grail of trading is a secret system that will let you win 100% of the time. They are wrong.

#The holy grail of trading is a system that lets you become profitable despite losses!

Its small difference in expectation but it makes ALL the difference.

Now let me explain the concept of risk and reward so you can understand how important it is to all of trading.

Imagine you and I are playing a game where I flip a coin and you try to guess which side it will land on. Every time you you guess you have a 50/50 chance to guess correctly. If you win, I give you a dollar. If you lose, you give me a dollar. You have a 50% win ratio and a 1 to 1 risk to reward ratio. If you always guessed "heads" statistically over a long enough period of time you will just break even. So how can we change this game to our advantage?

Lets agree that this time instead of winning just one dollar per flip, you win TWO dollars and a loss is still just negative one dollar. Lets also keep the win ratio the same. Now when we play the game all of a sudden you begin to make more and more money!

What is happening? Well lets look at the math. Lets say I flipped the coin 10 times and you won 5 times and lost 5 times (50% win ratio). I would pay you 2 dollars for each win. Since you won 5 times that means you get a $10 payout. At the same time you also lost 5 times. Since each loss costs you 1 dollar, 5 losses means you own me a $5 payment. So If I give you $10 and take back only $5, you still have $5 PROFIT left over!.

Everything has essentially stayed the same except the reward and it made all the difference.

Now if you apply this to Forex trading you can begin to see how big of a deal this is.

If you can win just 50% of all your trades (Everyone should be capable of doing this) and ALWAYS have a risk/reward ratio of 2 to 1. You WILL make money in forex. That's it.

What is nice is that once you set your risk reward ratio you can actually reduce the amount of win necessary to break even, meaning you account will be protected.

If your risk reward is 2 to 1, you can win only 34% of the time and still break even.

If your risk reward is 3 to 1, you can win only 25% of the time and still break even

If your risk reward is 5 to 1, you can win only 17% of the time and still break even

If your risk reward is 10 to 1, you can win only 10% of the time and still break even

The higher your risk reward the more you can afford to fuck up and the less wins you need to make money.

#Any win rate 35% and higher with a minimum of a 2 to 1 risk reward ratio or higher will be a profitable system.

So bringing it all together. If you can shoot for at least a 2 to 1 risk reward ratio with a 50% win rate YOU WILL BE A PROFITABLE TRADER. The math does not lie, its mathematically impossible for you to lose when you understand this concept.

So how does this look in a real trade you ask? Well lets say you risk 1% and set your stop loss at 20 pips. Well then you would set your reward at 40 pips or double that risked. if 20 pips equals 1%, then 40 pips equals 2%. If you wanted to change the risk reward ratio to 3 to 1 you would set the reward take profit at 60 pips which would be 3%.

The number of pips risked versus reward and when to enter and when to exit is for another lesson. That is part of creating your trading plan.

So recaping,

1 - when you set realistic expectations of success

2 - have a money manegement system that protects your accounts

3 - and understand how risk reward can make you money in the makets

You have a solid foundation for trading. However there is another lesson that is extremely imporant that has to be addressed.

Lesson 4: https://www.reddit.com/r/Forex/comments/6r8m9x/sandiegomagapede_trading_plan_lesson_4_emotional/

Lesson 2: https://www.reddit.com/r/Forex/comments/6oc7y2/sandiegomagapede_trading_plan_lesson_2_money/