Can the stop be greater than the take?

There are unbreakable commandments of trading. For example, that the take profit should always be 2-3 times higher than the stop loss, or better 5 times. Everyone agrees with these canonical recommendations from old, dusty books and…. They trade the other way around. Bigger stop, lower take. And then they feel guilty about the “wrong” risk management.

So where is the truth? Should the take always be greater than the stop? Should you consider yourself a sinner when trading with a big stop?) Let’s try to figure it out.

Positive expectation or your advantage in trading

To stay profitable after a large number of trades, you must have a positive expectation. Or, in other words, trade advantage.

Expected value is calculated by the formula:

(Average profit * ratio of profitable trades) - (average value of loss * ratio of losing trades) - transaction costs.

I’m not a fan of formulas. In my opinion, the table above gives a much clearer idea of what a positive expectation is.

If you have only 20% profitable trades, then in order to stay in the black and have a trading advantage, you need a Profit / Risk ratio of 5: 1 or more. Since the take-profit must be at least 5 times greater than the stop-loss.

With 50% of profitable trades, a Take / Stop ratio of 2: 1 is sufficient. But over 60% of profitable trades may have a stop even more than take profit.

From here we can draw the first conclusion - The smaller the take, the higher the winrate should be.

Feature of the Forex market

But what in practice? Have you seen a lot of long profitable manual trading monitorings or expert advisors on Forex, where profit is consistently several times larger than the stop? I’m not really….

And here we come to another nuance. It is necessary to take into account the peculiarities of the market in which you are trading.

Most of the books, where all these tips on the ratio of reward to risk come from, are written for the American stock market, which has a tendency to rise more than to decline.

And the peculiarity of the Forex market is the return to the average.

What I mean?

Take a look at the chart of the SP500 (US stock market index):

What do you see? It is obvious even to a child that the chart as a whole is growing.

Now let’s take a look at the notorious EURUSD:

What can you say about this chart? It grows, then falls, but tends as a whole to some average values. This is a return to the average.

From here we can draw another conclusion:

If you have a big stop, you can “sit out” the swing, if you have a big take, you can’t wait for it to be triggered out.

This does not mean at all that you cannot use large takes. They can and should be used when there are prerequisites for this. When your analysis shows that the price is really capable of hitting a big target.

Then you can set a big profit target. Not because you multiplied your stop loss by 5….

So what do you do?

So what can be done?

You need to place stop and take in accordance with the situation and your vision of the market, as well as in accordance with the strategy.

Here is the monitoring of the Survivor advisor:

For 4 years, the advisor has earned almost 400% of the profit. What are his take and stops?

Depending on the pair, on average the EA uses a stop that is more than 10 times higher than the take profit. Fearfully? It should be noted that it often exits the market before the stop, but also before the take.

Therefore, in the end, according to Myfxbook, the average profitable trade of the advisor is 2 times less than the average unprofitable trade.

Although I would describe a similar system for manual trading, in the comments I would be told that my head is not all right.

Nevertheless, if the situation on the chart and your analysis show that a big goal is achievable, then you should try to take it.

Example for the GBPUSD pair:

I bought from 200 SMA after false breakout. Placed a stop equal to 2 ATR.

And, according to my analysis, I expect the price to reach the level marked as take profit on the screen, which is about 2.5 times greater than the stop loss. Will the price go there? Maybe it won’t. But if I think this goal is adequate, why should I put a smaller take?

In a different situation on the chart, I would put a take equal to or even slightly less than the stop loss, if my analysis showed so.

Conclusion

So, the profit / risk ratio is not a dogma. You should always remember about common sense and adhere to the “golden mean” in order to maintain a positive expectation. Stop loss and take profit should depend on the strategy, the situation on the chart and your technical / fundamental analysis, and not because you set the stop at 10 points, but calculated the take profit by multiplying 10 by 5.

Also, do not forget about the peculiarities of the market that you are trading.

Take care, Michael

Forextraderportal.com

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