Trader Win Rate and Risk-Reward Ratio
This blog is the continuation of the earlier blogs on the Risk-Reward Ratio. This blog is about trader win rates, how to determine Risk-Reward Ratio, and the relationship between traders’ win rates and Risk-Reward Ratio. The aim is to help traders to find “the base Risk-Reward Ratio” for their trades and understand the Risk-Reward Ratio relationship with trader win rates.
What is Trader Win Rate?
It is a prerequisite to self-profile oneself before jumping into trading. How to know yourself in trading? There are several aspects of it. For example, identifying the trading objectives (trading versus investment), the type of trading (investor, day-trader, swing-trader, scalper), and the capital size, to mention a few. Similarly, the trader win rate is also an essential aspect of trading. Because if a trader does not know his win rate, he cannot manage his Risk-Reward Ratio for trades. A trader’s win rate is how many percentage times he is successful in his trades? The next logical question is how a trader would know his win rate?
The literature (textbooks on trading) and influencer traders suggest that every trader performs up to 100 trades and keeps a complete record. The information about each trade to be recorded includes: Why take a specific trade? What is the entry-level (the purchase price of the coin)? How much amount was invested (position size)? When was the trade closed? What was the profit/loss (result)? With these 100 recorded trades, the traders can find how many of these 100 trades were successful. Thus, he can determine his win rate in percentage. These 100 trades may be a lengthy and time-consuming exercise for many new young traders who always have a time shortage. Thus, a short version of this exercise is to have 10 to 20 recorded trades (the more, the better for more confirmation and confidence) and find their win rates. For instance, if someone made ten trades and won 6 trades while losing four, his win rate will be 60 per cent.
What Risk-Reward Ratio for Breakeven?
In an earlier blog, we did discuss the use of the Risk-Reward Ratio. However, we did not discuss how one can “set” a baseline Risk-Reward Ratio for oneself. By baseline, it means the “minimum” Risk-Reward Ratio a trader should set for his trade to stay at breakeven, based on his “profile”. Now we have sufficient background to discuss this concept.
Based Risk-Reward Ratio for a trader (to stay at breakeven) depends on his win rate and can be calculated as:
Risk : Reward = Loss : Win
For example, if a trader wins 60 per cent of his trades and loses 40 per cent, his Risk-Reward Ratio will be 40:60 or 1:1.5 to stay at breakeven. The trader with a 60 per cent success rate will be at breakeven if he keeps his Risk-Reward Ratio at 1:1.5. If he wants to stay in net profit, he must go for trades that can give him higher than the 1:1.5 Risk-Reward Ratio.
The above discussion implies the following important points.
- If a trader has a 60%-win rate and takes trades with a Risk-Reward Ratio lower than 1:1.5, he will get net losses, and his portfolio will decrease. Therefore, such traders must not consider any trade with a lower than 1:1.5 Risk-Reward Ratio.
- If a trader has a 60%-win rate and takes trades with a Risk-Reward Ratio equal to 1:1.5, he will be making some losses and some profits in his trades, but he will keep his portfolio unchanged.
- If a trader has a 60%-win rate and takes trades with a Risk-Reward Ratio greater than 1:1.5, the trader will be making a net profit, despite some losing trades, and his portfolios will increase.
How to Set Risk-Reward Ratio for Each Trade?
The real question is, if a trader has a 60%-win rate, then does he has to keep his Risk-Reward Ratio always at 1:1.5 in every trade? If he does so, he is only at breakeven. Rationality suggests he must take only those trades which have a Risk-Reward Ratio greater than 1:1.5 so that he stays in net profit.
The earlier process identifies the base level Risk-Reward Ratio that keeps traders at breakeven. However, the base level Risk-Reward Ratio of 1:15 cannot be ensured for every trade even if a trader has a 60% win rate because every trade is different. It has different resistance/support levels, price moments, timeframes, and market conditions. All these conditions “dictate” the Risk-Reward Ratio for a particular trade. So, every trade setup will have a different Risk-Reward Ratio.
The trader equipped with knowledge of Risk-Reward Ratio must take only those trades with a Risk-Reward Ratio higher than his base Risk-Reward Ratio. It will ensure his net profit in the trades he is taking. If he does not follow these guidelines, he will be in net loss, and his portfolio will decrease as he makes more and more trades.
Relationship between Risk-Reward Ratio and Trader Win Rate
A trader can determine his breakeven Risk-Reward Ratio from his win rate. But traders do not want to stay at breakeven; rather, they would like to earn profit. So, what Risk-Reward Ratio a trader should set (knowing his win rate already) that would keep him in net profit during trading? To be profitable, a trader must keep his Risk-Reward Ratio greater than his base level Risk-Reward Ratio from his success rate, as elaborated earlier.
Figure 1 shows the link between the baseline Risk-Reward Ratio (R: R that keeps a trader on breakeven) and traders’ win rate while considering a 1% loss in each trade. If a trader has a win rate of 95% (the first green bar), he must make trades with a Risk-Reward Ratio of 1:0.05 to stay at breakeven, and any trade having higher than this Risk-Reward Ratio will give him net profit. He should not take any trade that promises less than a 1:0.05 Risk-Reward Ratio. Similarly, a trader with a win rate of 70% (green bar) has to take only those trades with a Risk-Reward Ratio higher than 1:0.43 to be profitable. If he gets into a trade with a lower than 1:0.43 Risk-Reward Ratio, he will be in a net loss.
The link between Risk-Reward Ratio and Traders’ win rate is also presented in Table 1. The second and third column (in Table 1) shows the breakeven and profitable level of the Risk-Reward Ratio, respectively. For instance, for a 35 per cent win rate (red font in Table 1) trader, a trade having a Risk-Reward Ratio of 1:1.43 would be at breakeven, and a higher than this rate Risk-Reward Ratio will give him a net profit.
Warning while using Risk-Reward Ratio
The above-presented Graph and Table can be used as a guide for making a trade setup by traders once they know their win rates. However, it is important to warn the traders about a few issues while using the Risk-Reward Ratio. These warnings are outlined below:
- It is not a single isolated tool and an automatic way of making a profit. Risk-Reward should be used with other tools (1% rule, win-rate, position sizing) that may lead you to increase your chances of making profits.
- Never go for a trade that has higher risk and lesser reward.
- The traders should take only those trades that Risk-Reward Ratio keeps them either at breakeven or provide them with a net profit based on their respective win-rates.
Dr. M. S. Afridi