The Fallacy of Using SL/TP as Proxy Risk-Reward

illiquid
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The Fallacy of Using SL/TP as Proxy Risk-Reward

Post by illiquid »

First I want to say THANK YOU for all the interesting contributions in this forum! I was a lurker and my name is Chris, I come from Germany and I was trading part-time mainly futures for about 15 years and since a few months I trade full-time.

Since I want to learn more about risk management I came across this article from Steve Connell. What do you think about this? http://forexop.com/strategy/stop-loss-p ... x-returns/

Steve Connel:
Forex trading forums are full of well meaning, yet rather misguided advice about risk-reward setups and how to set your stop losses. Unfortunately, many of these people fail to understand the true meaning of risk or reward.

The idea that simply setting your stop loss smaller than your take profits will achieve a certain risk reward is complete nonsense.

Using risk/reward to set your trade entry and exits does not make any sense unless you know the probability of outcomes in a given trade.

Take this simple example. Suppose there is a lottery costing $1 to enter. The prize is $1m. By the definition of the naïve trader, this gives:

Risk: $1
Reward: $1m
Reward/Risk ratio: 1,000,000

By that definition, this would seem a fantastic game to play. However, suppose we know that two million people enter the lottery. This makes the odds of winning 1:2,000,000 (one in two million). Now we know the odds, we can calculate the true risk reward:

True risk: p(loss) x E(loss) = (1- 1/2000000) x ($1)
True reward: p(win) x E(win) = (1/2000000) x ($1,000,000)

True reward/risk ratio: 0.5
(...)
afeudale
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The Fallacy of Using SL/TP as Proxy Risk-Reward

Post by afeudale »

(First post for me! Yay!)

Agree with this 100%.

That quote is here and also elaborated on: http://forexop.com/strategy/stop-loss-p ... x-returns/

As an engineer/math guy, the logic was so convincing to me that I bought the Empty4 indicator (too lazy to calculate it by hand...lol). I'm not associated with forexop and don't get any commissions, so take my endorsement with a grain of salt :-)

It seems to be working well even though it is very difficult psychologically to get around the fact that my SL's are sometime 2.5x greater than my TP's!
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denya
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The Fallacy of Using SL/TP as Proxy Risk-Reward

Post by denya »

Yes. I have also previously studied this article and think it has a good sense.
Calculations are based on history for this currency pair prices.

The indicator would inform us about the most profitable sizes SL and TP, focusing on their own calculations.

There Excel file with calculations. Is possible to make indicator?
Thank you.
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tomele
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The Fallacy of Using SL/TP as Proxy Risk-Reward

Post by tomele »

denya » 04 Sep 2016, 17:51 wrote:There Excel file with calculations. Is possible to make indicator?
Of course this is possible. The creator of the Excel file already did it. Only problem, it costs something. You ask us to recode it for you to have it free? IMHO this is a request for theft. What would you say if you had developed this?

I am curious what the other members of SHF think.
Happy pippin, Thomas :-BD

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It's what you know for sure that just ain't so.
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denya
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The Fallacy of Using SL/TP as Proxy Risk-Reward

Post by denya »

tomele » Sun Sep 04, 2016 7:36 pm wrote:
denya » 04 Sep 2016, 17:51 wrote:There Excel file with calculations. Is possible to make indicator?
Of course this is possible. The creator of the Excel file already did it. Only problem, it costs something. You ask us to recode it for you to have it free? IMHO this is a request for theft. What would you say if you had developed this?

I am curious what the other members of SHF think.
Hello.

You are right and wrong at the same time. :)

1. Firstly, I do not ask to develop indicator for me. I ask for all.
2. Secondly, each of your development and development forum members deserve to be paid. All worth it! However, they are free. Why?
I also have a lot of development, and all of them are public and free of charge. Why?
There is only one answer. The rate of development of ideas is faster.
3. I really respect and appreciate the work that has invested in its development respected Steve Connel. Really not a standard approach.
4. I have an idea of ​​how to develop his idea into the module automatically calculate the most profitable size SL and TP. His indicator "as is" is not suitable for me ...
5. Your words: "IMHO this is a request for theft."
How can you steal a publicly laid out the idea?
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tomele
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The Fallacy of Using SL/TP as Proxy Risk-Reward

Post by tomele »

denya » 04 Sep 2016, 18:58 wrote: I also have a lot of development, and all of them are public and free of charge.
Hi,

thats great. Looking forward to your contributions here at SHF. We really appreciate members sharing their own developments.
Happy pippin, Thomas :-BD

It ain't what you don't know that gets you into trouble.
It's what you know for sure that just ain't so.
(Mark Twain)

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illiquid
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Joined: Fri Mar 04, 2016 7:51 am

The Fallacy of Using SL/TP as Proxy Risk-Reward

Post by illiquid »

In my opinion we should first discuss about the sense of Steve Connel's idea.

I can't evaluate this indicator and the spreadsheet, it seems to be not the common way of risk management, but it seems better than calculating R:R in the simple (wrong?) way?

@afeudale: do you use this indicator with every trade? Have you used the free spreadsheet? Are there the same numbers as the indicator calculates?

@denya: what is your experience with this way of risk management? E.g. do you think the stops are too wide?
afeudale
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The Fallacy of Using SL/TP as Proxy Risk-Reward

Post by afeudale »

@illiquid, I don't use the indicator with every trade, I am still getting used to how it works and I only trade on my live account (no demo).

But I do always look at it before taking a trade to see what it is telling me.

What I've found though is that it essentially tells you to place your S/L far away from your T/P. I think if one were just to use the rule SL = 2.5x TP might have the same effect...lol.

However, one thing it does do well is to calculate the TP - i.e. how far the market is expected to move within a given timeframe. This prevents greed and missed opportunity.

When I first started trading a few months ago, I always used a trailing stop, but now I realize how ineffective this was. If the TS was too small, then it would get hit too soon on a market retrace. If the TS too large, then you would miss the peak profit.

The idea of setting a target TP where the market "should" hit within the timeframe gives a much higher profit level - closer to the "peak".
illiquid
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The Fallacy of Using SL/TP as Proxy Risk-Reward

Post by illiquid »

@afeudale: thank you for answering my questions!

Now let's say you are in a trade and you want to move your TP to the next pivot. Does this indicator recommend then new SL or/and time how long it should take? Or if I enter a trade and I know for sure where the SL should be, does the indicator recommend TP?
afeudale
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The Fallacy of Using SL/TP as Proxy Risk-Reward

Post by afeudale »

I don't think it has the option to calculate. It basically is a real-time indicator, i.e. "if you were to take a trade now on this particular timeframe, then this is what your SL and TP should be".

However, sometimes I interpolate the numbers myself:

Example 1) If I really don't want such a large SL, but the next one down is too small, I will calculate a position in between (and also a TP in between)

Example 2) If the market moves in my favour by X amount and I would like to stay in the trade longer, I will modify the trade to use the current SL/TP values it provides, as if the trade was being entered now
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