Now, as the diagram shows, we ended up with a 9R profit. That means we netted 9 times our risk per trade. So, if our risk per trade was $100, we would have made $900 in this example. Keep in mind, that’s with a winning percentage of just over 36%. 

How is this possible?

The short answer is properly understanding and using of risk reward. The longer answer is this:

You have to understand that you NEVER know which trade will lose and which trade will win. So, since that IS the case, you should never expect to win or lose on any one trade. Even though we can tilt the odds in our favor by using price action setups, we can still never be certain when a 3 or 5R winner will come. 

Note in the diagram above there was a string of 3 consecutive losing trades, then a breakeven trade, then another loser and THEN a 3R winner. The implications of this example are quite profound, so let’s dig in a little deeper…

What is happening in your brain after you hit those 3 losing trades in a row? More importantly, what about after the breakeven trade and then ANOTHER loser? Are you going to freakout and bet the farm to try and make back the money you just lost? Are you going to enter a stupid trade on the 30 minute chart that you ‘rationalized’ to be a good setup when really it was nothing but a gamble? OR are you going to sit tight, stick to your guns, and remember that NOW IS THE TIME YOU NEED TO BE DISCIPLINED? It’s THESE MOMENTS that truly separate the winning traders from the losing traders. 

The thing that we need to understand is that you cannot let one trade’s outcome influence your actions in the market. Each trade is independent of the last. Just because you had a losing trade the last time does not mean you’ll have another loser on your next trade, and just because you just hit a 4R winner does not mean you’re gonna hit another one on your next trade. You have to approach each trade as ‘just another execution of your edge’, because that’s all it is. It’s nothing personal, the market doesn’t care about you, and your broker is not trying to screw you like so many amateur traders seem to think. The trade either wins or loses, that’s it, but you’ve got to decide how you manage it.

The ‘Mechanics’ of Risk Reward

Trade management is the ‘mechanics’ of risk reward; it’s what determines whether you get a 1R winner or a 3R winner. I get tons of emails from members and non-members alike on this topic, so I’m going to try and give you guys my ‘official’ position on it:

1) You need to understand that you never know what the market is going to do. You also need to understand that you are never going to be more objective, logical, and accurate in your trading analysis as you are when you’re NOT in the market. Therefore, if we accept these two FACTS, it goes to reason that the ‘set and forget’ strategy of trade management simply makes the most sense. Set and forget trading is HOW you let your trading edge (price action strategies) play out over time, because if you’re constantly interfering with your trades you’re never going to truly allow your trading edge or the power of risk reward to work out in your favor.

2) Most winning trades are going to be 2R or 3R winners, and you’re just going to let the market hit your target or hit your stop loss for your predefined loss. Occasionally, you’ll be able to trail your stop and ride a trend, but unless the market is selling-off and really in panic mode (like we have seen recently) or getting pushed higher everyday in a buying-frenzy, these times are rare. Most retail Forex traders have smaller accounts and so they should work to chip away at building them up by taking smaller 2R or 3R winners instead of trying to knock the ball out of the park every time. I find that most beginning and losing traders think EVERY trade is going to be a huge winner that moves 10R or more in their favor…and they are simply delusional, to be blunt. Once you reach a point where you are happy with your account balance and don’t need to build it anymore, then you can try to leave trades open for longer, because you’ll have an emotionally easier time not ‘freaking out’ when the inevitable counter-position retrace comes, because it will.

3) There ARE times when you can and should manually intervene in your trades. For example, you enter a long position from valid inside bar breakout in an obvious uptrend. The market goes about 1.5R in your favor and then forms a huge 1 hour or 4 hour pin bar against your position...in situations like these it's OK to manually close the trade out and take a smaller gain than what you wanted. Just be sure you have a PRICE ACTION BASED reason to close the trade out and you aren't just doing it because you just heard on Bloomberg that the market your in is going to move lower soon...or for some other stupid reason. Let the price action guide you. That said, MOST of the time I really do 'set and forget' my trades, and you should too, whilst still periodically monitoring the market's price action to make sure the conditions are not changing drastically. This is another one of those 'discretionary' aspects of trading that you will get better at over time. 

I trust you all have learned more about the power of risk reward in today's lesson. Remember to never get too attached to any one trade; each trade is independent from the previous one and never risk more than you are comfortable with losing on any one trade.

Good trading,