Book Review, Trade Recap, and Some Other General Thoughts
Given that I haven't posted in a while, there's a few things I'd like to talk about. Hopefully, I won't ramble too much.
Book Review: "New Trader Rich Trader" by Steve Burns and Holly Burns
Trade Recap: USDJPY buy at 109.10
Book Review: "New Trader Rich Trader" by Steve Burns and Holly Burns
I recently finished another Audible audiobook. This book does a decent job of covering the progression from "new trader" to "rich trader". The new trader started off with the intention of getting rich quick, but soon learned the difficult lesson of everything that goes into trading. It's a good book for those that have no idea how to trade, but it is a bit flawed. I don't necessarily agree with the mechanical system or trading rules outlined. The author, for example, gave really definitive statements like how you should buy above the 200 moving average. This statement is a bit misleading as there are additional factors one must consider when placing a trade. However, this book did a good job of stressing the importance of risk management. I'd take what the authors said you should do with a grain of salt. Like the example listed, the authors listed several trading buy and sell rules quite definitively. I think that's something every reader should come to the conclusion of in their own observation.
While I don't find this book helpful for my own trading psychology, I do have some takeaways. Specifically, it made me realize how flawed the pursuit of the reward to risk ratio really is. I'll elaborate in its own separate section.
Trade Recap: USDJPY buy at 109.10
I entered four trades this week - two got stopped out and two made money. For my future self looking back at this post, I have posted the P&Ls below. They probably aren't too significant for what I want to recap in this section.
USDJPY Buy: -$201.23
NZDJPY Buy: -$225.42
AUDUSD Sell: $317.64
AUDCHF Sell: $368.57
Three out of the four trades followed my system of a breakout rejection (fakeout). USDJPY was a little bit different. Before I conduct the post-trade analysis, let's run through my thought process for this trade.
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| USDJPY H4 |
What I think is interesting about this trade was that I identified it as a breakout. In other words, I anticipated a breakout continuation instead of waiting for weakness and shorting. In a previous post, I talked about how this is not my nature to be buying on a bullish breakout because the price has already rallied so much. Based on the screenshot, you can see that price initially sold off and then recovered. This has happened twice, see if you can spot them.
I approached this chart by looking at how price was making higher highs and higher lows. When price made a relative low, I entered long. I do think that my analysis was suboptimal and I'd like to reflect on that.
- It's not my nature to trend trade. I shouldn't have even considered this pair on the long side at all. The reason is because of how much this pair have rallied. I'm essentially buying at the tail end after everybody else. It just doesn't make much sense to buy when others are starting to look to sell. My mindset has always been to look for opportunities to sell as a pair rallies - look for exhaustion rather than to try chasing.
- While I did count fractals making higher highs and higher lows, I neglected to focus on the size of the movement. Even though the turnaround was very quick, the second reversal was exhausted very quickly. Another sign was that price immediately stopped after barely breaking previous relative highs. If I were to trend trade, it'd make more sense on lower timeframes.
Given that I've had very little success trading continuation breakouts, I should just stop making this attempt entirely. This is something I'll have to be more conscious about in the future. I just thought that it was interesting I decided to make this trade.
Finally, my interpretation of the reward to risk ratio
I originally heard the conventional way of looking at this ratio over on the Limit Up! podcast. I believe this was the episode (source) featuring Erich Senft. In light of my recent trades, I think I have my own thoughts about how this metric should be used.
The conventional use of this ratio is a bit problematic. There are quite a few "mentors" or "teachers" that tell you to target at least a 3:1 reward to risk ratio. They often say that if your trade is lower than this ratio, you will not be profitable. I think this "rule" is quite problematic. Here's why.
Another common saying is that you should know when to get out before you enter the trade. In other words, when you decide to take a trade, you need to know where you're going to get out if the trade doesn't work out. You need to determine how big of a loss you want to take for this trade. Let's use my AUDCHF sell trade as an example. I planned my stop loss at 40 pips. In order for me to enter this trade, my take profit must be at least 120 pips. This will guarantee me a 3:1 reward-to-risk ratio. You can probably see how this is starting to look problematic.
How the fuck am I supposed to know that this pair will go down 120 pips? Also, why would I look to get out at 120 pips if this pair keeps trending lower? Double also, what happens if this pair only moves 20 pips lower and then signifies bullish strength? Would I get out or commit to riding it to 120 pips?
If you use the reward-to-risk ratio rule to help you enter trades, it's going to cause you a lot of headaches. I'm not saying to completely throw out this rule, but you do need to change up how you use it. It's a good metric to use alongside your win/loss ratio. If you target a 1:1 reward to risk ratio, you can still be profitable if you have a win/loss ratio of 9:1. The reason why traders need to target a higher reward to risk ratio is because their win/loss ratio is lower. If your win/loss ratio is 1:9, that means you only make money on 10% of your trades. Your strategy must yield a reward to risk of over 9:1 for it to work out. Please take careful note about how I framed that previous sentence. I'm using the reward to risk ratio to evaluate the strategy. I'm not fitting my profit target to a specific reward to risk ratio, which would be impossible.
I came to the realization that my AUDCHF trade only had a reward to risk ratio of 1.6. I thought that this was problematic until I reviewed my analysis entering into the trade. Since I traded off of a fake out where price made a strong bearish move, there was a much higher probability that the pair was going to go lower as opposed to higher. If I statistically average about 1.6 or 1.5 to 1 reward to risk ratio, I will need to ensure that the probability of the trades going in my favor is at least 60%.
With that said, I think I have changed my perception of the reward to risk ratio metric. On a side note, I wouldn't necessarily say I'm fully committed to this reasoning nor am I insisting that this reasoning is correct. If new information comes to light that changes my perception, I simply need to factor said new information into my decision making process in order to improve the decision quality.
If you use the reward-to-risk ratio rule to help you enter trades, it's going to cause you a lot of headaches. I'm not saying to completely throw out this rule, but you do need to change up how you use it. It's a good metric to use alongside your win/loss ratio. If you target a 1:1 reward to risk ratio, you can still be profitable if you have a win/loss ratio of 9:1. The reason why traders need to target a higher reward to risk ratio is because their win/loss ratio is lower. If your win/loss ratio is 1:9, that means you only make money on 10% of your trades. Your strategy must yield a reward to risk of over 9:1 for it to work out. Please take careful note about how I framed that previous sentence. I'm using the reward to risk ratio to evaluate the strategy. I'm not fitting my profit target to a specific reward to risk ratio, which would be impossible.
I came to the realization that my AUDCHF trade only had a reward to risk ratio of 1.6. I thought that this was problematic until I reviewed my analysis entering into the trade. Since I traded off of a fake out where price made a strong bearish move, there was a much higher probability that the pair was going to go lower as opposed to higher. If I statistically average about 1.6 or 1.5 to 1 reward to risk ratio, I will need to ensure that the probability of the trades going in my favor is at least 60%.
With that said, I think I have changed my perception of the reward to risk ratio metric. On a side note, I wouldn't necessarily say I'm fully committed to this reasoning nor am I insisting that this reasoning is correct. If new information comes to light that changes my perception, I simply need to factor said new information into my decision making process in order to improve the decision quality.