# How to become a good Stock Trader –Article 2 – Risk-Reward Ratio

The major problem which a trader faces problem is to follow a disciplined approach. In all my previous posts i have been mentioning about discipline,strategy though i rarely get time to put in more details on the trading part of analysis as well as people are more interested in stock specific recommendations or rather a technical view on the index.

So will try to start a new series of articles which would be based on topics which would help me and lot of traders 🙂

Some days back i had posted a similar article which could be a good read before you start on the current article.

The first terminology which is the basis of doing trading. Apart from being able to find right trades and right analysis one needs to follow a good discipline to make money.

What is more surprising is you need to have only a 50-65% accuracy ratio provided one uses a good risk reward.

The three parameters to know before calculating a Risk-Reward Ratio are

2) Target Price

3) Stoploss

Risk = Buying Price – Stoploss

Reward = Target price – buying price.

Risk-Reward Ratio = Target Price / Risk

So lets see an example how does one calculate the Risk-Reward Ratio before taking a trade. Once that is done all one needs to do is execute mechanically.

So let us see what the 3 parameters were

1) 54.3

2) 60 /66

3) 52

Now let us see how the calculations take place.

Risk = 2.5

Reward = 5.7 / 11.5

Risk-Reward Ratio = 5.7/2.5 = 2.3 or 11.5/2.5 = 4.6

So Risk-Reward Ratio is roughly 1 : 2.3  or if 2nd tgt is done it would be 1:4.6.

So calculation part is understood now we look into the execution part.

The execution rules are as below.

1) Exit when 1st target comes. ( am not considering 2nd tgt also)

2) Exit when Stoploss Hits.

Once the risk-reward and system is known let us see what would happen in a real life scenario where you do many trades and you right as well as wrong.

Suppose if i take 4 such trades in which two go right and two go wrong with a risk reward of roughly 1: 2.5 ( ideal for quick traders)

Consider following criteria for simplicity and you have bought 1000 shares.

Target Price = 125 and 140

Stoploss = 90

1) Profit = 25000

2) Loss = 10000

3) Loss = 10000

4) Profit = 25000

Net Profit = 30000

So from the above thing it is clear that 4 trades were taken so money deployed is 4 lakh rupees. The net gain is 30000 rupees which is still a clean 7.5% on the capital deployed.

Isn’t this an awesome return if you can get trades with a risk-reward ratio of just 1:2.5.

But reading through this you did not realize that you were right only 50% of the time in predicting a good stock move and you still made a clean RETURN !

The point is clear that making Money in trading can be much more easier if you would apply simple risk management techniques with DISCIPLINE:)  and you need to be right only 50-70% of the time to have a consistent performance. ( But the best way to sell Advisory Services is to say 95-100 % accuracy rate !!! )

For the record i am very happy if i can achieve beyond 75% as my general accuracy rate is 60-75% only which still can give consistent returns.

The only time to deploy over leverage is special scenarios where suddenly the risk reward ratio is excellent. The last time advised leverage was at 16000-16400 stoploss of 15900. Target Price 17100/18400. This gave me a risk-reward 1:3 to 1:7 ! which is super !

For the last few years i have been trying to deploy the above principles as the base of my trading advisory services and disciplined people have been consistently making money.

Also learning through the process of trading with the basic principles and how to mechanize the whole process of trading without emotional attachment 🙂

Next week we may look into how to take into time as a parameter in trading decisions.

P.S: By the way when K S Oils dropped from 54-55 to 52-53 in the day i did get many queries like WHAT TO DO? STOCK IS DROPPING ? Will this move like CHAMBAL FERTILIZERS?

The whole point is you need to size your position in a manner that a 5% stoploss does not bother you and you dont get greedy before the 10-15% target.

Will try to cover Risk Management and Position Sizing in the next post when i get time.

I believe the above article was as boring as the one before as this article is of no material use and no gains or losses can be made but if you still liked it and would want many of your other friends to read and get bored please take the liberty to do so through yahoo, facebook, orkut and other communication or spam mediums 🙂

Regards,

Nooresh

Analyse India

mail me on noorrock2002@gmail.com if you have some inputs or use the comments section.

#### Article by Nooresh Merani

##### Nooresh has written 2745 articles.

• Rithik October 27, 2010, 00:26

Hi Nooresh,

Regards
Rithik

• Nirmal October 27, 2010, 05:19

Hi Nooresh,
Thanks for writing a very good article for the people who do not calculate risk-reward ratio before entering into a trade. Few month ago even I was in the same catagory. Like not maintainig stop loss or exit full/a part in 1st target. However, your I really appreciate your TA & Stock selection.
Thanks again,
Cheers,
Nirmal

• nooresh October 27, 2010, 14:02

Hi Nirmal,

Welcome and thanks for the appreciation.

• kunal gosar October 27, 2010, 08:40

good way of making one understand the simple rules of the game

• naihvik October 27, 2010, 10:50

superb article…
specially when u gave example of ksoil

• Gaurav October 27, 2010, 11:04

Xcellent article!!!

• vithal nakrani October 27, 2010, 11:14

dear sir
i observe from 18 to 119.85

• vithal nakrani October 27, 2010, 11:24

dear sir
iregular reader of your blog .i observe lsind (bse code 514446) from 18 to 119.85 daily 100 share volume for your information waiting for your opion on blog thnks

• Asawari I. October 27, 2010, 13:38

The article is very interesting, useful and practical. Frankly speaking, I am one of those who hesitate to follow stoploss, considering its a loss and faced a huge loss in past. Thanks to your excellent elaborative article, henceforth, I would definitely go with stoploss!

• nooresh October 27, 2010, 13:59

Hi Asawari,

Yes its necessary to keep stoplosses to reduce the risk of being stuck in some real bad move.

• Amit October 27, 2010, 14:23

Sir what is your view on HDFC, falling every day. Is it the buy at current levels. Please give technical view on it.

• Gaurav October 27, 2010, 16:19

Hi Nooresh,

Excellent Post and something which everyone should keep in mind while trading. Higher RR ratio gives comfort and one can trade with higher capital in the trades having better RR reatio.

One small question Nooresh – How is ‘Suryachakra Power Corporation Ltd.’ from a 5 years perspective and can it be a 5 bagger in that period?

Cheerz
Gaurav

• bhanu October 27, 2010, 17:38

hi Nooresh,

As usual this is realy useful stuff. a Quick question, if, in you recommendation when you do not give a stop loss for a investment pick does it mean accumulate at all dips?
for a trade Stoploss matters for investment does it matter or how do we decide?

thanks
bhanu

• rm October 27, 2010, 19:32

Hi Nooresh

Very useful post. Thanks!

Regards.
rm

• sarika October 27, 2010, 20:09

hi nooresh,
an invaluable article -actually helped me get the perspective right. i have always been into investments, but yes now i get the trading fundas right .thx a ton. do keep posting such articles.
looking forward ,
sarika

• nooresh October 28, 2010, 10:36

Hi Sarika,

Thanks for the appreciation.

• teju October 27, 2010, 21:00

Hi nooreshji,

I am holding valechha (201), HEG (321), Prakash ind (168), Beckons ind (8.2),
Ramsurp ind (39.5), Koutons (115). Please guide me in above scrip

• nooresh October 28, 2010, 10:35

Hold Valecha for 180-185 bounce to reduce. heg prakash beckons shud shift.
Ramsarup and Koutons a high risk high returns.

• Ramesh October 27, 2010, 22:34

HI Nooresh,

I am holding 1 lot of HDIL NOV series long @268, Would you please let us know, Should i exit tomorrow or how to manage this loosing position..

Thanks,
Ramehs

• nooresh October 28, 2010, 10:35

Hi Ramesh,

Would suggest a exit rest is your call.

• xyz October 27, 2010, 23:24

Nooresh bhai ready with your diwali picks … Sir pls give us a stock like lic housing which can turn out to be a 10 bagger in a 2-3 years time … Last diwali sipped in delta corp and booked @ 80 … Hope this diwali brings joy and fortune for everyone… Update on hinduja ventures bought @ 450 n 425 .. It goes up and again comes down .. Should I hold or sip it for long term

• abc October 27, 2010, 23:29

Nooresh bhai ready with your diwali picks … Sir pls give us a stock like lic housing which can turn out to be a 10 bagger in a 2-3 years time … Last diwali sipped in delta corp and booked @ 80 … Hope this diwali brings joy and fortune for everyone… Update on hinduja ventures bought @ 450 n 425 .. It goes up and again comes down .. Should I hold or sip it for long term

• nooresh October 28, 2010, 10:34

Hi Abc,

Well we try but one needs to look more conservatively in a 1 year call in current scenario.
HInduja is a good bet but will test patience.

• Gaurav October 28, 2010, 09:45

Hey Nooresh,

How is ‘Suryachakra Power Corporation Ltd.’ from a 5 years perspective and can it be a 5 bagger in that period?

Cheerz
Gaurav

• nooresh October 28, 2010, 10:33

Hi Gaurav,

Provided the company does what it has been saying

• patidar October 28, 2010, 10:11

Hello Nooresh,

Please give some really good calls..Awaiting.

• nooresh October 28, 2010, 10:32

Hi Patidar,

• Nirmal October 28, 2010, 12:42

I am not sure why no one is projecting. I am expecting previous high should be touched at least if not cross by Diwali and CIL listing.

Let us see..RIL will blast according to my understanding.

• nooresh October 28, 2010, 12:55

Hi Nirmal,

My view on index is positive. Please check previous reports

• saurabh October 29, 2010, 11:02

nice article and always eductive , even ur charts help us to learn,
i think this is a bonus on diwali
thanx

• nooresh October 29, 2010, 11:22

Hi Saurabh,

Thanks:)