Day Trading Strategies : Accuracy Vs. Risk : Reward Ratio ?…. which is most important ?
As question is mystical , so I am going to answer it in mystical way….If you understand then you will get what you want (profit)….if you didn’t understand then you also you will get but what you don’t want (loss)
First understand what is mean by accuracy ?
Suppose you are using any trading strategy , and you executed consecutive 10 trades (plz make sure that rules remain same for all trades i.e. Entry rule and exit rule). Out of that 10 trades , 5 trades end in profit and 5 trades end in loss. Then you can say that accuracy (Or success rate) of this particular trading strategy is 50%
Now understand what is mean by Risk : Reward ratio ?
Suppose you bought any share at Rs.10 and as per your strategy if stop loss price is Rs.8 then your Risk in this particular trade is Rs.2 , and if you exited at Rs. 20 , it means that you had made profit of Rs.10. Means your reward in this particular trade is Rs.10
So , to calculate Risk : Reward Ratio ,
Risk = 2
Reward = 10
Means , Risk : Reward Ratio is 1:5
While developing any trading strategy , Accuracy and risk to reward ratio are two important factors , and they are inversely proportionate to each other.
Let’s understand , How ?
Day trading strategy having success rate of 50% and average risk to reward ratio of 1:3 , is also profitable.
Suppose from this strategy you made 10 trades , then as per accuracy , your 5 trades are going to end up in profit and 5 trades are going to end up in loss.
Suppose you are taking risk of Rs.100 in each trades.
Then in 5 loss trades , you are going to lose Rs.500
And as average risk to reward ratio is 1:3 , means you are going to make Rs.300 in winning trade on an average.
So , for 5 winning trade , total profit will be Rs.1500
So,Lets do calculation for Day trading strategy, Having accuracy (Success Rate) of 50% and Average risk to reward ratio of 1:3
Total Trades : 10
Risk per trade : Rs.100
No.of trades end in Profit : 5
No.of trades end in Loss : 5
Amount of money lose in 5 loss trades : 5 X 100 = 500
Amount of money made in 5 winning trades : 5 X 300 = 1500
After , 10 trades ,
Net result = Profit – loss
= 1500 – 500
So , after 10 trades , with day trading strategy having accuracy (Success rate) of 50% and average Risk to reward ratio of 1:3 , you are going to end up in profit.
So, to become CONSISTENTLY successful trader , your day trading strategy should have OPTIMUM accuracy and MAXIMUM Risk to reward ratio.