Examples of Risk / Reward in Action
The following examples are all of daily pin bars that have occurred in recent weeks in the forex and spot metals market. The purpose is to show how using a risk / reward of 1:2 (or greater) can allow us to lose more trades than we win while still turning a solid profit.
These are all hypothetical examples, for sake of ease and illustration we will assume a starting balance of $5,000, risking $100 per trade with a reward set at $200 per trade, for a risk / reward of 1:2. The examples are presented in chronological order to make it more realistic. Now, follow along as we go through some real-life examples of how risk / reward actually works.
EXAMPLE 1: Gold daily bearish pin bar
The daily gold chart formed a bearish pin bar reversal back on January 19th. The 8 / 21 day emas were crossed lower at the time this pin bar formed, and it showed clear rejection of the 21 day ema. So, this pin bar was valid and was with the decreasing market momentum at the time. Ideally, we would have liked to see the tail of the pin a bit longer, but it was still a valid setup.
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We can see this setup worked out very nicely, and it actually provided the possibility of making 3 or 4 times risk, but for the sake of this article we will assume a reward of 2 times risk, as stated previously. So our updated account balance and trade history now looks like this:
Balance: $5,000 + $200 = $5,200
Trade History: 0 losers, 1 winner
EXAMPLE 2: NZDUSD daily bearish pin bar
The NZDUSD formed a bearish pin bar January 28th. This pin bar was off on obvious resistance area and a similar pin bar had formed and worked well off this same resistance about 7 days earlier, so it’s entirely possible that traders would have viewed the January 28th as a valid counter-trend trade. The main reason to not have taken this trade was that the 8 / 21 emas were crossed higher on the daily and weekly charts, so momentum was more bullish than bearish, even though the market was in a trading range at the time.
This setup most definitely would have resulted in a loss had you shorted it, it provided very little time to move stops to breakeven. So our updated account balance and trade history now looks like this:
Balance: $5,200 - $100 = $5,100
Trade History: 1 loser, 1 winner
EXAMPLE 3: EURGBP daily bullish pin bar
Back on February 1st the EURGBP formed a decent (but small) pin bar off the 21 day ema and horizontal support area at near 0.8500. This setup could have been viewed as a possible resumption of the upward momentum, as the 8 / 21 emas were crossed higher at the time this pin bar formed. So, even though it was a small pin bar, it was a valid one showing a possible entry into the recent bullish momentum with the backing of multiple factors of confluence behind it, as discussed above.
This setup would have resulted in a loss. So our updated account balance and trade history now looks like this:
Balance: $5,100 - $100 = $5,000
Trade History: 2 losers, 1 winner
EXAMPLE 4: GBPJPY daily bearish pin bar
We can see in the chart below the daily GBPJPY chart formed a well-defined bearish pin bar on February 3rd. The setup was counter-trend; however, due to it being at a very obvious and significant horizontal resistance area, some traders may have taken this trade. It could have been considered a valid counter-trend setup, even though we ideally would have liked to see the pin bar make a clearer break and rejection of the 133.00 resistance.
The setup would most likely have resulted in a loss had you shorted on a break of the low, unless you moved your stop to breakeven after the trade moved into profit, but for examples sake we are going to assume you did not move to breakeven on all of these examples. So our updated account balance and trade history now looks like this:
Balance: $5,000 - $100 = $4,900
Trade History: 3 losers, 1 winner
EXAMPLE 5: EURAUD daily bullish pin bar
The EURAUD is not a pair we discuss very often, but it did form a quality pin bar setup off support back on February 4th. This setup could have been entered on a retracement near the 50% level of the pin. A risk reward of 1:2 would have been obtained by now and a larger R/R was certainly possible from this setup.
This setup resulted in a winning trade and would have put us back above our original $5,000 starting balance. So our updated account balance and trade history now looks like this:
Balance: $4,900 + $200 = $5,100
Trade History: 3 losers, 2 winners
Recap:
From the above 5 examples we can take away the following lessons:
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· With a risk / reward of 1:2 or greater, we can lose over 50% of our trades and still profit
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· An experienced price action trader exercising a refined sense of discretion and patience in the market should easily be able to obtain a winning percentage of around 50%, a winning percentage of just 50% combined with a consistent risk / reward of 1:2 will make you a very profitable trader over a series of trades.
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· It is important to not get attached or emotional to any ONE trade, remember that you will have losers, and probably strings of consecutive losers. The above example had 3 losers in a row, you could have more than 3 losers in a row, even when trading quality price action setups, but if you are consistent in your execution of trades and your risk / reward, eventually you will hit a series of winners that will more than make up for your losers.
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· Furthermore, if you only trade with the trend and from obvious levels of confluence and obvious PA signals, you are unlikely to have a long series of consecutive losing trades.
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· Risk / reward needs time to play out, if you take rewards of smaller proportion than 2 times risk, keep in mind you are going to HAVE to win about 50% or more of your trades to make money. The best professional traders in the world only average about 50-70% winners. Most professional traders (including myself) only win around 50% of the time.