Can one simple change make a huge difference in trading? YES. I have worked with numerous traders, both experienced and inexperienced. During working with one client, I had him send me his trades in an Excel spreadsheet. With one look I knew what his biggest obstacle was at that particular moment — it’s called an inverse risk to reward ratio or negative expectancy.
While experienced traders (those that have consistently been making money) can use an inverse risk to reward because their winning percentages are higher, traders that do not consistently make money CANNOT DO THIS!
One Change Can Make a Huge Difference in Trading
Here is the random P/L and Drawdown chart based on 118 trades using his risk to reward ratios (not his actual chart but the random trade generator with his parameters):
However, his winning ratio was actually at 47%, not far from the 50-50 probability that is expected. Is there any hope? YES — by simply turning this risk to reward to a positive expectancy.
Using the same number of trades and only changing the risk to reward to $1 risk for $2 of gain, the P/L with Drawdown changes to this:
Once the trader conquers the risk to reward aspect, then he can focus on other aspects of trading (incorporating indicators, defining his trading plan, etc) but to begin, he must devise a positive expectancy based on his experience level.
Then he has to be dedicated to the trading plan to allow the sample size to grow and probabilities to work in his favor. This is, again, where most traders fail. They expect profits immediately to fall into their lap because most are under capitalized and cannot withstand the drawdowns that all traders will eventually have – in other words, they need immediate profits to build the account.