Many people perceive profitable as those who win 70% of the trades. The fact is, profitable traders should be seen from their wins and losses. A balance between win-rate and the risk-reward ratio is essential for success in trading.
Win-Loss Ratio in Day Trading
Most day traders only focus on getting high win rates. They want to win almost all of their trades. Yet, having a high winning rate will not directly make you a successful trader or a profitable trader.
A win rate represents a trader number of winning trades from all of the trades he or she has made. For instance, with five trades in a day, a trader wins three. The, his win rates is 3/5=0.6. In 20 trading days in a month, the trader wins 60 from 100 trades, then the trader’s monthly win rate is 60%.
Meanwhile, the win-loss ratio is calculated by dividing the winning trades by the losses. For example, a trader wins 60 trades and losses 40 trades.
If there are no flat trades, then that trader’s win-loss ratio is 60/40=1.5. That means the trader is winning 50% of the time more than he or she losing.
The favorable win-loss ratio is above 1.0 or wins a rate above 50%.
Risk-Reward Ratios in Day Trading
A risk-reward ratio represents the amount of profit you expect on a trade relative to the amount you willing to lose.
Most of the day traders want to enter the market, and exit quickly to get the advantage of short term patterns and trade signals. To reach that, day traders need to put a stop loss in their trades.
That stop-loss decides the cents, ticks, or pips you want to risk in the stock, future, or forex pair. For instance, if you want to risk $0.10 on stock BBB, then buy at $10.00 and place the stop loss at $9.90.
That way your fixed risk is $0.10, but you also need to give up the potential profit. On the other hand, profit target represents your expected payoff.
For instance, if you take $10.10 profit, with both potential profit and risk of $0.10. Thus, your risk/reward ratio is $0.10/$0.10=1.0.
But, if you increase your profit into $10.05 with the potential risk of $0.10 your reward is only $0.05. In this scenario, your risk/reward increases to 2.0. That shows you take more risks and make less profit.
