Hi Mike,
Just finishing your book One Good Trade with this take away. I am determined to master the skill of ‘reading the tape’, believing that to be the golden key to my future success as an intraday trader. Thanks for infusing me with new motivation. One question. I’m a little confused about how to actually measure the risk/ reward going into a trade. I know the formula is a ratio of 1/5, but how exactly do you measure those numbers.
Bella Responds
It takes experience and a feel for each set up. You estimate where you will get out if you are wrong. You estimate where you will exit if you are correct. And then you get a ratio. For developing traders we ask them to think about ratios of a downside of 1 and an upside of 5. So if your estimated loss is 10c then you must have an expected upside of 50c. If not then this is not an excellent risk/reward for developing traders. As you progress you might look for risk/reward ratios of 1×3. There are many traders very content mastering setups of 1×2 risk/reward. But at the start it is best to focus on controlling your risk and the more opportunistic, easier trades. You build your base from here and then expand.
There will be times when you poorly estimate your risk reward. What is important is to calculate your risk/reward before each trade. And work to make sure you are getting better at such estimations and are disciplined with your exits.
Mike Bellafiore
Author, One Good Trade
4 Comments on “Traders Ask: How Do You Determine Your Risk/Reward?”
It would be great if you could give a couple of rules of thumb for your sl and target estimates! Thanx
determining an initial risk / reward and trading with that objective in order to achieve good risk adjusted returns is easy when you scale in and out in just a couple of parts but how are you maintaining that ratio while you’re literally chopping in and out of the stock with every turn of the tape, especially with the frenetic style of trading employed by gman ? please give a practical example of this using numbers. i’m sure many developing traders will benefit from that.
Mike – Quick question. Do you think it is sound advise to adjust your risk:reward dynamically as the trade develop? I ask because there are times I find price seems to stall ticks away from my original profit target and I ask myself does it make sense to risk – say 40 ticks – to make an additional 10?
Mary
buttonwoodtrader.com
As long as before you entered the trade you considered this option and concluded you might. Great question.