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Accuracy Vs Risk-Reward Ratio -The Trading 101

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Accuracy vs Risk-Reward Ratio

This website is free and supported by readers. This post may contain affiliate links. Read the disclosure for more info.

I have been thinking about writing something on money management, I just didn’t know where to start. Of course, I do not claim as an expert on this topic, I am just sharing materials I have learned.

Accuracy vs Risk-Reward Ratio

There are times I read traders’ blog who revealed their risk-reward ratio when making certain trade. Some traders are trading with 1 R in order to earn 0.3R (basically, risking $100 to earn $30, that’s the idea).

There is nothing right or wrong in the trading business, I am not arguing if the trader is doing the right thing. I am interested in looking at some simple mathematical details of this risk plan.

Accuracy or winning rate is the percentage of winning after a serious of trades.

Just how much accuracy is required from your system for you to be profitable after a certain number of trades when you are risking, say, $100 to earn $30 each trade?

Accuracy = (Number of wining trades/Number of losing trades) x 100%

Risk-Reward Ratio is the ratio of the amount you will lose if a trade is stopped out and the profit amount if a winning trade is closed.

Risk-Reward Ratio = $loss/$Win

I found an excellent spreadsheet from Kreslik.com (An excellent forum, with some great traders sharing strategies, programming etc). I have recreated the spreadsheet and it can be found here. moneymanagementchartupload.xls

Feel free to download a copy and play around to get the idea.

Let’s take an example, risk amount $100, profit target $30.
rr1to3

As you can see, with this risk-reward ratio, you will need a system/methodology that gives 80% accuracy in order for you to be profitable.

A system with over 80% accuracy?

Well, I believe it does exist, but I have no luck to see it so often. Most of the time, I will be happy if my system gives me over 60% accuracy or sometimes, just around 55% accuracy.

This time, I am risking 1 R in order to earn just 1.5 R (risk $10, to earn $15).
Here is the result.

rr1to15
With 1:1.5 Risk-Reward Ratio, you need 50% wining rate to be profitable

Basically, it is just like a coin tossing game, I need 50% accuracy in order to be profitable.

How about risking 1 R to earn 1 R?

Not a good idea. Remember, commission kills.

Accuracy vs Risk-Reward Ratio : 1R-1R
with 1:1 Risk-Reward ratio, you need to product at least 53% accuracy to be profitable

For example, we assume each trade, $4 is required for the round-turn commission. With a 1:1 risk-reward ratio, over 100 trades, we are still at the losing end, if our system is unable to produce 53% accuracy.

You can try out different Risk/Reward combinations in the spreadsheet.

Accuracy vs Risk-Reward Ratio – Final Words

Some simple calculations do help traders to understand the nature of trading. It is crucial to have a good understanding of these concepts between you start trading.

Trading is a long game. Having a good understanding of risk management will go a long way.

If you think it is ok to risk bigger dollars to earn a small profit, make sure you have a high accuracy system that pays you.

Tool I use

The Advanced Calculator from Forex Smart Tools is one of the best retail money management tools I have used. It helps to calculate and fine-tune my overall risk plan before I put on a trade.

It is a robust tool that caters to different trading styles including cost-averaging, stop-and-reverse, and multi-leg positions, etc.

If you are interested in finding more about the journaling tools I use in my trading, check out the resource page for more details.

What is your winning rate and risk-reward ratio in your trading? Which money management tool do you use for your trading?

Do you have any questions or comments? Please feel free to drop me a line in the comment section. I am happy to help.

12 Tips For Writing a Business Plan [Update 2022]

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writing a business plan

Here is another masterpiece I found from Linda Raschke‘s articles.
I would only list out the key points which I have found to be useful for me to write my trading business plan.

Here is a list of some of the types of things you can include in your annual business plan. The list will give you something to work on. Start thinking about putting together a professional program, comprised of bite-size pieces.

Tips for Writing A Business Plan
  1. What methodology or patterns are you going to trade?
  2. Which markets are you going to trade?
  3. How much capital are you going to put into your trading accounts?
  4. How do you plan to enter, exit, and manage trades?
  5. What is your plan to manage drawdowns?
  6. What are your monthly goals?
  7. Include a daily routine in your overall business plan.
  8. Create an office environment designed to facilitate performance.
  9. A contigency plan for interuption from non-trading events
  10. Record Keeping. Keep a record like your life depends on it
  11. Rewards! All work, no play makes Jack a dull boy.
  12. What plans do you have to continually improve yourself?

Tips for Writing A Business Plan For Traders

What methodology or patterns are you going to trade?

It is OK to have a “library” of setups, but most people do best concentrating on a niche or particular technique. Learn to do one thing consistently well instead of trying to master too
many styles.

Writing a business plan - Know your timeframe

Which markets are you going to trade?

If you trade equities, think about keeping a “stable” of stocks to follow. Don’t get caught up in scanning a database of too many issues that you are not familiar with. It invites unfortunate
situations where there may be pending issues or reports in the company that you are unaware of.

If you have not had much success trading soybeans or silver in the past, why try to continue to trade them in the future?

How much capital are you going to put into your trading accounts?

Something I have to add here, stay away from looking at percentage returns when evaluating performance statistics, such as percent return or drawdowns, on your personal account.

Concentrate instead of dollar amounts.

What is your dollar amount tolerance? My stomach turns at a specific dollar amount drawdown. Percentages vary too much according to how much money you keep in your account.

You might have a net worth of 1 million. Keeping 100,000 in your trading account and your situation will be entirely different than a person who has 5 million and keeps 100,000 in the trading account.

The person with the higher net worth will feel freer to use a different type of leverage. So think in terms of dollar amounts…how much are you willing to draw
down to?

How do you plan to enter, exit, and manage trades?

writing a business plan - The trading process

I like dividing my contract size into two units. Sometimes I go all in and then scale out in halves. Other times I put half on and look to add the other half. Some positions I keep half on as a core
and use the other unit as a scalping unit.

Whatever style you choose, it should be written down into your plan.

What is your plan to manage drawdowns?

You will have drawdowns. It is unavoidable. What is your plan to manage them? How will you evaluate when you need to take time off? Put down the plan in the business plan now.

What are your monthly goals?

Are you going to strive to make a certain number of trades each week or perhaps a certain number of SP points? Remember, these are guidelines by which to measure your progress.

Some months will be better than in other months. The end of the month is a good time to do a periodic review. Most businesses do this on a monthly or quarterly basis.

Include a daily routine in your overall business plan.

How are you going to evaluate your performance each day? Keep a notebook of the things you do RIGHT.

Pat yourself on the back for small moral victories, such as exiting a losing position swiftly. Note the small incremental improvements you make.

Create an office environment designed to facilitate performance.

Eliminate distractions and outside influences. Reduce glare and get a comfortable chair. Invest in good equipment. Invest in an excellent data feed.

A contigency plan for interuption from non-trading events

Include a provision that will keep you from trading if outside circumstances create unusual stress, such as health, divorce, or a major move.

You might as well just write a check out of your trading account and kiss it goodbye. This is a hard thing to recognize before it is too late. People LOSE money during times of 10 major stresses: death, taxes, divorce, moving, health…you get the point.

Trading is a performance-oriented discipline. If you can’t perform well, cancel the show

If a tennis player severely sprains his ankle, he cancels the match. Why do damage to your ratings? Why mar your statistical record with sub-optimal performance?

Record Keeping. Keep a record like your life depends on it

Rate yourself on your routine and structure and nightly homework. Do you do research or have a way of logging results? What type of research is included in your program or plan?

My problem is I stack too many projects up on back burner. I need to streamline this area for myself. Or, I get diverted doing research, go off on a tangent late at night and stay up way too
late. Then I am not in optimal condition the next day. My business plan includes bedtime. I promise myself to adhere to it.

Rewards! All work, no play makes Jack a dull boy.

You must have outside interests or hobbies to get your mind off the markets at the end of the day. You must treat yourself to something you really want.

If you spend money on yourself you will eliminate subconscious poverty thoughts. I am serious. Treat yourself like a million bucks and you will be worth it soon.

Maybe after a good week, you treat yourself to a massage or buy something you want. I already have something in mind that I will do for myself if I meet my goals next year. It is something that does not cost too much but that I could never justify spending money on because it might seem frivolous. But the money comes from my trading account so nothing is frivolous!

What plans do you have to continually improve yourself?

See yourself as a top-notch person, health-wise, performance-wise, and attitude-wise.

How do you keep advancing in life? You know the old saying, if you are not going forward, you are going backward. Educational pursuits such as books and study courses are important but don’t neglect spiritual pursuit, or outside projects…perhaps building your website, starting your trading network, writing your book on all the trails and tribulations of the business, or working with a charity.

Writing A Business Plan – Final Words

writing a business plan - Follow the process and make money

I do not need to emphasize the importance of having a business plan. This post is not a step-by-step guide on writing a business plan. The goal is to give you the key elements to include in your plan.

Trading is a long journey. It is not going to be easy. Having a plan to guide your through the ups and downs will certainly help.

I hope this post is useful to you.

Do you have any questions or comments? Feel free to drop me a line in the comment section. I am happy to help.

VWAP vs VWMA – The Simple Guide

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VWAP vs VWMA

VWAP is one of the popular indicators used by traders. It is an intraday indicator, which best serves short term, particularly day traders.

Because of the volume component and the similarity of its name, traders often confused VWAP and another volume-associate indicator VWMA.

This is your simple guide of VWAP vs VWMA.

Are VWAP and VWMA the same? The answer is NO. Fundamentally, they are different. They serve different purposes.

If you are looking for an explanation of VWAP and VWMA, you are in the right place.

In this post, I will show you the difference between VWAP and VWMA.

We will look at the construction of these two indicators. The best way to determine if an indicator is useful to your trading is to understand the math behind it.

Without further ado, let’s look into the details now.

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Tradingview is my go-to FX charting and trading solution. I have done extensive coding and trading on the platform. I am happy to recommend them.

If you are interested in using Tradingview, you can try out the Pro membership FREE for 30 days. This is an excellent time to check out the powerful features of Tradingview charting.

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VWAP vs VWMA – The fundamentals

VWAP vs VWMA on intraday chart
VWAP & VWMA on intraday 1-minute chart

What is VWAP?

VWAP stands for Volume Weight Average Price. It is a day trading indicator. The indicator’s calculation resets at the beginning of each trading session.

VWAP is widely used by both institutions traders and retail traders. Institutional traders use it to guide their positioning decisions while retail traders mostly use it to decide if the market is under or overvalued.

To understand how to effectively use VWAP, let’s look at the construction of the indicator.

How to calculate VWAP

VWAP is the cumulative average price with respect to the volume.

Take note that VWAP uses the typical price. Typical Price can be calculated by averaging High, Low, and Close prices.

Typical Price = (H+L+C)/3

Let’s look at the formula of VWAP.

VWAP = Cumulative(Typical Price x Volume)/Cumulative (Volume)

Or

VWAP formula

A quick explanation of VWAP calculation:

  1. Calculate the typical price of a specific time period by (High + Low + Close)/3
  2. Multiply the volume of the period to the typical price. (Volume x Typical Price)
  3. Calculate the cumulative total of (Volume x Typical Price) since the session’s open.
  4. Calculate the cumulative total of volume since the session’s open.
  5. Find the ratio of Cumulative Total of (Volume x Typical Price) and Cumulative Total of Volume. This is the VWAP.

VWAP applications

Institutional traders use VWAP as a benchmark for their trade executions. Institutional automated trading strategies often execute their orders around VWAP to avoid a huge spike in volume.

For day traders, VWAP serves as a reference point. It is similar to the Volume Point of Control of Volume Profile. Traders use it as a reference to decide if the current market price is over or undervalue.

What is VWMA

VWMA stands for Volume Weight Moving Average. The name often confused traders.

VWMA is one type of moving averages. In addition to closing prices, VWMA incorporates volume into the calculation.

If you are familiar with the moving average, it is easy to get a hang of the concept of VWMA.

How to calculate VWMA

To understand the calculation of VWMA, let’s start with Simple Moving Average.

A Simple Moving Average is the average of closing prices over the past N periods.

For example, 3-Day Simple Moving Average

3-Day SMA = (Close1+Close2+Close3+Close4+Close5)/5

Now, let’s look at the VWMA. Volume Weight Moving Average is calculated as below:

C=Close

V=Volume

3-Day VWMA= (C1xV1+C2xV2+C3xV3)/(V1+V2+V3)

As you can see from the formula, each closing price is weighted with its volume. In other words, the closing price with higher volume carries more weight in the calculation.

Difference between VWMA and SMA
The difference between VWMA & SMA

The chart above illustrates the difference between VWMA and SMA.

SMA rises when the market rises, as it is an average of closing prices over the past 20 periods.

For the same look-back period, the VWMA moves below SMA when the market is trading higher but with lower volume.

VWMA applications

If you have already used a moving average in your trading, VWMA might give you additional insight.

There are traders using VWMA & SMA crossover to determine trend strength. This approach adds a new dimension to trend analysis with volume weighting.

Trading with VWAP

Day trading example using VWAP, volume profile, and order flow
Example of day trading Futures with VWAP, Volume Profile, and Order Flow

As a day trader, VWAP is one of the essential tools in my trading. I mainly used it in futures trading.

There are many ways to trade with VWAP. One of them is to work along with Volume Profile and order flow analysis.

With the understanding of the Auction Market Theory, you can build an effective day trading strategy.

Recently, I have been trying it in the Forex market. Although tick volume is less than desirable, it does offer a good general read of the market.

Conclusion – VWAP vs VWMA

I hope you have a good understanding of the constructions of VWAP and VWMA now.

The key differences between VWAP and VWMA are:

VWAP is cumulative of average price with respect to volume. It does not drop off any data over time. The calculation begins at the start of the trading session.

VWMA is a type of moving averages. The indicator calculates the average of closing prices with respect to the volume. It has a fixed period where older data will be dropped off from the calculation. The calculation is continuous across sessions.

They are different indicators and should not be confused.

Indicators could be useful to your trading, It could hinder your trading as well. In trading, less is more.

You do not need more indicators to achieve success. As a rule of thumb, if it confuses you, chuck it in the bin.

Trading Tools

The charts posted on this post are created using TradingView. It is my recommended charting platform for Forex trading purposes. It offers a wide range of market data, the flexibility of strategies and indicators building using PineScripting, and live trading integration.

If you are interested in knowing more about the tools I use in my trading, such as trading journal, charting platform, or trading course check out my Resource page.

Do you have any experience trading with VWAP or VWMA?

Do you have any questions? Feel free to drop me a line in the comment section. I am happy to help.

How To Draw Support Resistance Levels- A Simple Guide

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How To Draw Support Resistance Levels
Table Of Contents
  1. What is the support resistance level?
  2. Guidelines to draw support and resistance levels
  3. How to draw Support Resistance levels – Final words
  4. Try Tradingview Pro Charting Platform For 30 days

Support and Resistance levels are one of the oldest and yet, the most effective methods, to analyze and trade the markets. It is so simple that it is often overlooked by new traders.

It is overlooked because new traders often get attracted by the fancy strategies or indicators.

In this article, let’s have a look at how to draw support resistance levels effectively.

I didn’t invent the strategy, I learned it. I have been trading for over 14 years. And I can’t remember how many books and courses I have read and studied. Everything you read on this blog is the result of years of trading and learning.

The methods might not be original, but they are effective.

Without further ado, let’s move on to look at what support resistance levels are, and how to draw them effectively.

What is the support resistance level?

The textbook definition:

Classical Support Definition

From Technical Analysis of The Financial Markets by John J. Murphy

Support is a level or area on the chart under the market where buying interest is sufficiently strong to overcome selling pressure.

Technical Analysis of The Financial Markets by John J. Murphy

Visually, think about the price levels that the market repeatedly tests or the level with multiple swing lows. That’s where the market finds support.

Classical Resistance Definition

Resistance is the opposite of support. It is a level or area over the market. Selling pressure overcomes buying pressure here. A price advance is turned back.

Technical Analysis of The Financial Markets by John J. Murphy

(But hold on, it does not mean you should trade at this level just yet, keep reading)

These are the text-book definition of support and resistance. But that is not what I would use to trade.

But they said Support and Resistance is a zone

Yes, that’s not wrong.

I prefer to start looking for a level and expand around it to construct a small zone.

In this post, I will focus on looking for a high probability level.

When I draw support resistance levels, there are few guidelines I follow. There are no hard rules. The more you practice, the more you will learn.

In general, I found these guidelines are pretty effective.

When drawing a support resistance level, start from a higher time frame, and working down to the lower time frame.

Don’t waste too much time on the “muddy” area. Always look for the obvious. Focus on the clean levels.

Guidelines to draw support and resistance levels

#1 The more touches a level has had, the more significant the level is.

More touches a level had, the more significant it is

A price level that the market respects and reacts serves as a good support resistance level. Use this as one of the factors when drawing a level.

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#2 The longer a level is held, the more significant it is when it is broken.

The longer a level is held, the more significant it is

Similar to point 1, when a support or resistance level holds up the market for a long time, it is significant. The market respects it.

When it is broken, it signals the major change of sentiment, and it serves as an excellent trade location.

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#3 The more times a level is tested, the weaker it becomes. It is more likely to be broken.

The more times a level is tested, the weaker it becomes

Surprised?!?

The old wisdom taught us, the frequently tested level shows strength. The truth might be just the opposite.

Let’s put it this way:

A support level holds up a price because there are buying orders waiting. The orders could be from any sources. Be it bank, retail, or institutions.

However, when the same level has been tested multiple times, the orders are filled and eventually will dry out.

What will happen when there is no more buy order to hold up the price? Where do you think the market will go now? It tanks.

The same principle applies to resistance levels.

The more time a resistance level is tested, the selling pressure (the sell orders) at the price level is consumed and reduced.

When the sell orders are drying out, breakout happens. The market continues moving up until selling orders appear.

As a guide, I keep a rule of two-touches:

I only trade at the first and second touches of a support or resistance level. After the first two touches, I will wait for the break of that level to decide the next action.

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#4 The inverse support or resistance levels are the ideal trade locations

The inverse support or resistance levels are ideal trade locations

What do I mean by “Inverse Level”?

Inverse support is a broken support level. It becomes a resistance when the market revisits the level.

Inverse resistance is a broken resistance level. It becomes support when the market revisits the level.

When a level is broken, it signals a change of sentiment. It shifts the willingness of buying or selling.

Let’s take a support level as an example. When a support level is broken, it signals the selling pressure overtakes buying pressure. In other words, there is a new willingness to sell.

When the market revisits the same level, it is likely to find resistance at the level.

How to decide which inverse level to trade? This brings us to the next point.

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#5 Look for an inverse level that was tested multiple times before it was broken.

Inverse levels

The more times a support level is tested, the stronger the inverse level will be.

When a support level is tested multiple times, buy orders are filled. It takes a lot to break a strong support level. Eventually, selling pressure overtakes the buying, the support level is broken.

There are now more selling interests below this level. It now serves as a strong resistance level.

The same rule applies to a resistance level.

To define a good inverse level, I apply a rule of two-touches:

Broken resistance turns support

When looking for a support level, I prefer a broken resistance level with at least 2 touches before the breakup.

Broken Support turns Resistance

When looking for resistance level, I prefer a broken support level with at least 2 touches before the breakdown.

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#6 Focus on recent price action and work your way to the left

Some traders like to go as far as they can to draw levels based on historical swing points. Well, they might be right, but that’s not what I would do.

I am a short term trader. I focus on the most recent price structure because that is what the market is “thinking” right now.

I put more weight on the recent swing points when drawing support and resistance levels. It could be days or weeks. I won’t go back years of data to draw levels from there.

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Try Tradingview Pro Charting Platform For 30 days

Tradingview is my go-to FX charting and trading solution. I have done extensive coding and trading on the platform. I am happy to recommend them.

If you are interested in using Tradingview, you can try out the Pro membership FREE for 30 days. This is an excellent time to check out the powerful features of Tradingview charting.

Tradingview 30-day FREE Pro membership trial

How to draw Support Resistance levels – Final words

Support and Resistance levels are one of the many ways you can use to look at the market. It has been used by professionals, but there are also many of them that do not use it. It is not a holy grail.

Trade Location + Entry + Execution + Management

Secondly, support and resistance levels are used as trade locations. That’s just one piece of the trading puzzles. The next step is to work on your entry method, execution, and finally management.

If you are looking for an example on how to use support resistance levels, I wrote a short blog post about using Support Resistance levels to manage your exist strategy.

Thoughts

Let me “destroy” your dream before we finish up this post. If you are constantly looking for some rules you can follow and start making money, you will be disappointed.

There are no exact rules you can follow in trading.

It is always through discovery and testing. Failures after failures. And maybe, more failures. You need to find a methodology that fits you.

Having said that, study and improve your skills in identifying support and resistance levels give you a good head start.

Alright, this post is longer than I expected. Hopefully, I offer something useful.

Tools For Traders

All charts posted on this article are prepared using TradingView. TradingView is my recommended Forex charting platform. It is web-based, stable, and offer a great range of market data. It offers both free and paid plans.

If you are interested in learning more about the tools I used in my daily trading business, check out the resource page here.

Do you have any questions or comments? Feel free to drop me a line in the comment section. I am happy to help.

Next trade is more important

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I was having a walk after buying food from the supermarket with my fiancee.

The next trade is more important

I told her about my recent trades, I was pretty happy with my performance. She smiled and told me ‘ It is good, but the next trade is more important’.

This gives me some thoughts. Exactly, the next trade is always more important. And the very next trade has totally nothing to do with our recent trades which we turned a profit or loss. However, human natures make us think it may. We will end up with overconfident, or timid when making the next trade.

Forget about your past trades. Keep the focus on the price action, and the next trade is always more important. You have to give the best performance for the next trade, it might not be perfect, but it will be your best shot!

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Sierra Chart sharing: ChartDom Entry chart

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Chart DOM is one of my favourite Sierra Chart features. It gives users the flexibility to synchronize chart, and DOM. Chart DOM has all features of traditional Sierra Chart DOM, with ability to attach (and synchronized) into a chart. Sierra Chart DOM is higly customisable, and light weight.

In my trading, I always have a chart, which I call “Entry Chart”. It is a simple Footprint/Numbers Bars with Chart DOM attached. I have customized the Chart DOM with additional columns such as Bid/Ask Market Pulling stacking, Recent Bid/Ask volume etc.  The main purpose is to have a quick view of price movement (from Footprint/Numbers Bars chart), while trading on DOM.

I have attached the chartbook here. Please feel free to download, customize, and share it if you found it helpful.

You can download the chartbook HERE.

Enjoy!