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Looking for input on the 2:1 risk reward and calculations and how/when to apply. I'm starting off with the premise of Al's repeated statements of:
- look to the left
- Trade the trend
- Most breakouts fail
- That there is a trade-off versus reward and risk meaning that if there is a greater certainty for something to happen you have to accept less reward.
- It is mathematically unrealistic to take any trade that doesn't give you a two-to-one versus reward
And it leads me to the issue of how to calculate a 2:1 risk versus reward. Especially if you have to put the stop at the most recent credible low. It seems to me that where you would find these two to one ratios would be at Key resistance or supports.
I often think possibly wedge bottom/ wedge top /double top/ double bottom. How does one calculate the 2:1 if you are in a downtrend? If you have a wedge bottom that implies selling pressure possibly ending then you wait for 2 to 3 good bull bars closing on their highs. I presume that would be the risk and that you would need to wait or wade through all of the prior selling in order to get the reward. In today's 1/7 trading room Tim S had mentioned that it was a training range day and that 2:1 3:1 were tough to come by and many people would be doing 1;1. I asked him about the 2:1 logic and the possible limits of the availability for credible buys at a 2:1. He stated that there were multiple examples of two to one in today's session. However the examples that he showed were buys at the top of credible resistance points, the overnight High, for example. He pointed out as a credible Buy for 2:1 as well at a wedge top. I have heard Tim say on multiple occasions about being late to the party meaning the credible buy is often much earlier that I would be able to identify which would mean that the risk to reward would start at a different location not just the location that I would enter.
My question is two fold: When is a true 2-1 calculated? Surely it cannot be as arbitrary as ‘two good bull bars” and which takes more precedence support and resistance zones recognizable chart patterns such as a wedge or just ‘two good bull bars’ closing on their tops even if they were at the top of the day's range and or the high of yesterday.
If I see a good buy signal bar at the bottom of a wedge, do I not need to wait for a second or a third good bull bar? If yes Am I not buying into someone else's 2:1 target point? The same would be true for a second entry correct? I am buying and a higher price therefore should not expect a 2:1. If true isn't the 2:1 a fallacy? If not a fallacy, then when is the 2:1 to be applied, because it cannot be applied with every trade.
A discussion of risk: reward without probability is meaningless. You can have a reward of ten times risk but if the probability is 1% that is a losing strategy. You want to look for situations where the Trader's Equation gives you a positive edge. Buying pullbacks in a strong trend, especially second entries, gives you good risk: reward AND good probability. Buying at the bottom or selling at the top of large enough Trading Ranges also gives you a good TE. Waiting for a MTR with good context can give you a good TE. Traders frequently make the mistake of looking for trades with small risk like breakouts or counter trend trades, but these almost always have very low probability and therefore don't make up for the seemingly small risk.
Good reply Andrew!
There are several factors which much be balanced: risk/reward and probability are the "money management" factors of profitability, but they are not sufficient because they do not include bias.
Bias is determinable by pattern to some degree. The easiest mechanism is to hop aboard a trend, as already stated. 1:1 is the scalpers profit and it is the easiest mechanism to begin with - - why? The underlying question which is always being asked is "is there a bias". Al has documented the aspects that help to qualify that in his course. If there is a bias, then probability should be 50%+ or greater. Some of the patterns are simply a method for directional bias to "bleed out". Wedge pattern being a notable case.
2 reward vs 1 risk is swing trading. The MTR is the easiest case but recognize that probability is only 40%! And that IS THE BALANCING ACT. There isn't a "free lunch" of 1:2 [risk / reward] without a probability offset. This is why reading directional bias and the factors that help to determine probability can take a little while.
Hopefully helpful and good trades to you!
Thank you.
