Risk vs. Reward: A recipe for success

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2 Risk vs. Reward: Key for trading longevity Trading the financial markets is as much about capital preservation as it is about capital appreciation. Successful traders will tell you that before placing trades it is paramount to measure both how far you believe a trade can move in your favour as well as how far you would realistically let it go offside before calling it a day, the latter being crucial as a reminder that your money is at stake on every trade. Only when these two numbers are identified can you calculate what is key in prolonging your trading longevity - the reward-to-risk ratio/multiple which dictates whether trades are worth the risk. When risking 1,000 you are unlikely to do so for equivalent gains (reward-to-risk ratio of 1:1, or multiple of 1x) - unless it is a dead-cert, of course, but unfortunately the markets offer very few of these, if any. If you did trade on this basis, and assuming (realistically) that you are not successful on every trade, maybe getting 5 of 10 trades right (50%), a reward-to-risk of 1.0x on each trade would see profits from winning trades offset by losses from losing trades (white boxes in below table). A lot of effort and risk for nothing and no guarantee of you achieving 50% success. Net trading P&L using reward-to-risk multiple 1.0x In order to get your account balance positive (green shaded section, rising up the blue boxes) using a risk-to-reward multiple of 1.0x on every trade you would need to wither increase the number of winners versus losers (eg. 6 winners vs 4 losers, 7 vs 3, etc; easier said than done) or for profits to exceed losses. Assuming you have little, if any, control over the former, the easiest way to better the situation is to work on the latter by increasing the quality of any potential profits by identifying more attractive reward-to-risk ratios. Our research is produced by Accendo Markets Limited. Research produced and disseminated by Accendo Markets is classified as non-independent research, and is therefore a marketing communication. Accendo Markets research has not been prepared in accordance with legal requirements designed to promote its independence and may not comply with FCA guidelines to prevent conflicts of interest and is not subject to any prohibition on dealing ahead of the dissemination of research. As such, this research does not constitute a personal recommendation or offer to enter into a transaction or an investment, and is produced and distributed for information purposes only. Accendo Markets considers information contained within the research to be valid when published, and gives no warranty as to the investments referred to in this material. The income from the investments referred to may go down as well as up, and investors may realise losses on investments. The past performance of a particular investment is not necessarily a guide to its future performance. Prepared by Michael van Dulken, Analyst

3 Increasing the reward-to-risk multiple of your trades by 50% to 1.5x means that whilst you are still rising 1,000 on every trade (speak to us about protective tools to limit losses) your potential profits from those which go according to plan would rise by half to 1,500 per trade. Net trading P&L using reward-to-risk multiple 1.5x Across a total of 10 trades and with an unchanged 50% success rate, the above table shows how your net gains would rise to a healthier 2,500 - significantly bettering your previous treading of water. Best of all, if your success improved to 60% (6 winners, 4 losers) your profits would rise to 5,000. On the flip side, if your hit rate deteriorated to just 40% the new 1.5x ratio would still allow profits to offset losses. Note also that a 1.5x multiple allows 6 winners to offset 9 of your losers. If we assume that to really increase your chances of making a net profit across multiple trades you need to increase the multiple further, to 2.0x for example, the table below shows how 50% success across 10 trades would deliver you net profits of 5,000. It would also allow your success to fall to 4 in 10 and still net you a 2,000 profit whilst rewarding any boost in hit rate to 60% and above with profits exceeding 8,000. Note also that 5 winners would offset up to 10 losses, while 4 would offset 8. Net trading P&L using reward-to-risk multiple 2.0x

4 As an analyst producing trade ideas for clients I tend to focus on ratios of 2.5x and above. If I assume that Accendo Markets clients follow a run of my ideas and that I don t get them all right (I too am realistic I work hard to identify good ideas but if I did get them all right I would work for myself, from a tropical island), my aim is to have the few hopeful winners offset the likely several losers. As the table below shows, if you increase your ratio to my preferred minimum level of 2.5x your net profits across 10 trades would rise to 7,500, assuming 50% success. If we are pessimistic and assume as low as 30% success (just 3 out of 10 trades right) you would still bank a 500 profit - not great, but still better than breaking even after all that work and a helpful contribution to covering trading costs. Net trading P&L using reward-to-risk multiple 2.5x If your success improved to 60% profits would rise to an impressive 11,000, which could be used to covering another 11 losses if you had a bad run, and extremely significant is that just 4 winners would be able to offset up to 10 losers. Once we get into the realms of risk-to-reward multiples of 3x and above profits across 10 trades with 50% success rise to 10,000 and just 3 winners suffice to numb the pain from 9 losers. Anything better and profits increase significantly, while success can drop as low as 30% and still generate 2,000 profit. Net trading P&L using reward-to-risk multiple 3.0x

5 But that s so obvious Many will claim that what we have looked at is very obvious, but it is extremely common to see even seasoned traders repeatedly making the same mistakes; a) Risking too much on a few trades (all their eggs; no diversification); b) Assuming success rates will be higher (natural optimism), and; c) Focusing too much on what can be made as opposed to what is being risked (see above). Whilst I agree that trades can always come good it is a very one sided argument which ignores the fact that things also can always get worse. Once offside, a trade has to do a lot of work just to recover to breakeven, never mind make a profit as was originally forecast. Avoiding closing out of a trade at your pre-defined worst-case level goes against your trading strategy and setup. What changed your mind? It was your worst case scenario and now it s worse. Keeping it open and hoping it recovers also deprives you of the chance to preserve capital and more importantly put it to work in a better trade idea. Think before you trade Next time you re about to place a trade identify your worst and best-case price scenarios. Make sure you re realistic with both, remembering that you re risking real money. Now take the multiple of profits versus losses and decide whether the aggregate profit across 10 trades (assuming a realistic success rate) using a similar setup would be worth the work involved in placing and monitoring. The higher the multiple you use, the more green there will be on the P&L tables and thus the more chance of making a net profit across the trades and the fewer winners you will need to offset the several losses. As a reminder, the lower the multiple you use the lower the profits potential from any winners and less profits there will be to offset the inevitable losses. Trading less but more wisely, spending more time more time identifying better setups is a solid recipe for a long and ultimately profitable trading lifetime I hope that what you have read is a breath of fresh air, makes you think the next time you trade and ultimately helps you in your pursuit of long-term and profitable trading. This is just one of many educational pieces which we provide to trading clients, and we hope you will join us soon. Mike van Dulken, Head of Research To find out what makes Accendo Markets stand out from the rest...

6 The Accendo approach what s different? At Accendo Markets we don t tell you what to do. It s your call whether you buy or sell. Our aim is to provide the help you need highlighting opportunities which may be profitable to you, the trader, and assist you in making trading decisions which can benefit from the use of leveraged instruments. Our approach focuses on 3 elements below; Education - not obligation Observations - not recommendation Assistance - not persistence Our unique and award-winning service provides you with the help and tools you need to make appropriate trading decisions in the financial markets, both to grow and protect your capital. How do CFDs come into it? CFDs offer a simple way to increase your profit potential. Purchasing traditional shares requires the full amount be paid up front (10,000 shares of Company A at 100p, requires the full 10,000 outlay). With CFDs, however, the initial outlay for an identical trade could be as little as 500 (CFDs require only a deposit - as low as 5% for equities). Whilst the outlay is lower the risk and reward remain the same as if 10,000 of physical shares were being held. The CFD trader benefits/suffers to the same extent as the traditional shareholder but benefits from not having to part with the full amount at the outset and saves on stamp duty as there is no physical purchase. Best of all, you can take a positive or negative view. Think the shares will rise? Take a long position by buying the CFDs. Think its shares will fall? Take a short position by selling the CFDs. For a more detailed rundown of CFDs, their mechanics and some trading scenarios click here. Beware, however, that the combination of CFDs leverage and bigger share-price movements (volatility) can result in bigger than expected losses which can even exceed your original deposit Should you have any questions on how to trade Shares, Indices, Commodities or FX via CFDs, including ways in which your risk can be managed, call us to discuss on Open a Demo account CLICK DEMO Subscribe to a Free Research trial CLICK RESEARCH Apply for a Live Account CLICK ACCOUNT

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