In today’s post I will explore Profit / Loss Ratio, Win / Loss Ratio, Win – Rate and Risk / Reward Ratio, and how they could aid you in your trading.
Profit / Loss Ratio:
The Profit / Loss Ratio is the average of the profitable trades divided by the average of the losing trades over a certain sample / number of trades that was taken of a given trading system. The Profit / Loss Ratio is one measure that can be used to check the performance of a trading system.
Again, the Profit / Loss Ratio = (Average Profit per trade) / (Average Loss per trade) for a given number of trades.
So let’s say for example that after a certain number of trades you want to calculate the Profit / Loss Ratio of those trades. You find that after adding all your profitable trades and dividing it by the number of profitable trades you get an average profit of $700 per trade; this is your average profit per trade. Also, after you added all your losing trades and divided it by the number of losing trades you get an average loss of $400 per trade ; this is your average loss per trade. Your Profit / Loss Ratio = $700 / $400. = 1.75 (Average Profit per trade) / (Average Loss per trade) for a given number of trades.
What is a good Profit / Loss Ratio? That’s hard to answer; every trader and trading system is different. One possible way to use it is that if you have a backtested system and it’s given you a certain Profit / Loss Ratio (for the backtested period), you wouldn’t want it to deviate too much from when you start trading that same system live; if it does it might warrant some investigation as to why it’s happening.
Win / Loss Ratio and Win – Rate:
The Win / loss Ratio is just the number of winning trades divided by the number of losing trades (Win / loss Ratio = Number of Winning Trades / Number of Losing Trades) for a certain number of trades; this means the Win / Loss Ratio is the number of winning trades with respect to the number of losing trades over a given sample of trades.
As an example let’s say you are 20 trades in since you started trading your system on a live account and you want to calculate your Win / Loss Ratio, and of those 20 trades 11 was winners and 9 losers. Your Win / Loss Ratio = 11 / 9 = 1.22 (Winning Trades / Losing Trades).
A Win / Loss Ratio of 1 means that your wins are equal to your losses. So if your ratio is bigger than 1 it means that you win more than you lose and if your ratio is less than one you lose more than you win (over the period calculated).
Your Win – Rate will be your number of winners divided by the total number of trades (Win – Rate = Number of Winning Trades / Total Number of Trades) taken over a given sample of trades. From the same example above (20 total trades, 11 winners and 9 losers), the
Win – Rate = 11 / 20 = 0.55 or 55% (Number of Winning Trades / Total Number of Trades).
A Win – Rate of 0.5 or 50% means that your winners are equal to your losses. So if your rate is bigger than 0.5 or 50% it means that you win more than you lose and if your rate is less than 0.5 or 50% you lose more than you win (over a calculated period).
Again it’s hard to give an exact answer to what a good Win / Loss Ratio or Win – Rate is as it will depend on the kind of strategy you are trading. A scalping strategy for example will have many winners and very little losers whereas a trend following strategy will have little winners but many small losers; can you see how their Win / Loss Ratios or Win – Rates will differ?
Risk / Reward Ratio:
The Risk / Reward Ratio of a trading strategy is simply just a measure of what a trade is expected to return versus what the predetermined risk is of that same trade. When entering a trade you will have an entry price, profit target (price where you would like to take profits) and stop loss (price where trade is proven wrong). Your risk (amount potentially stand to lose) will be the entry price minus the stop loss price. Your potential reward (profit) will be your profit target – entry price.
So let’s say (for simplicity sake) that your strategy is so that every trade that is taken the risk you take is $1 and the potential reward / profit is $2. This means that your Risk / Reward Ratio = Risk:Reward = 1:2.
The Risk / Reward Ratio you will determine before you enter a trade, but the Profit / Loss Ratio, Win / Loss Ratio and Win – Rate you can only compute after you have completed some trades. The numbers (Profit / Loss Ratio, Win / Loss Ratio and Win – Rate) will keep changing the more trades you take which can give you some valuable insight into how your trading is going.
Here is a very simple example:
Let’s say that your strategy is of such a nature that it only takes trades with a Risk / reward Ratio of 1:2. And after calculating your Win – Rate after some 30 trades you find it to be 0.5 (50%) meaning you win on 50% of your trades, but the look of your account balance tells you that you are losing money. How is that possible? Winning half your trades with a Risk / Reward of 1:2 but still losing money; what can this mean? Something like that should be worth investigating. You might find for example (after your investigation) that you are cutting your winners too soon; another is that you are not adhering to your stops and taking bigger losses than you should. This example was just for illustrative purposes but hopefully it gives you an idea of how these formulas / ratios can be used once you’ve gathered enough data.
And that’s my post for Profit / Loss Ratio, Win / Loss Ratio, Win – Rate and Risk / Reward Ratio. Hope this post has been helpful.
Thanks and Regards,
Trading SOS SOS