The Handbook of Technical Analysis + Test Bank_ The Practitioner\'s Comprehensive Guide to Technical Analysis ( PDFDrive )

Money Management

Assume Take Profit (T/P) = 200 pips

Our R r ratio/ ==×$ / $R r ( minilot) / ( × minilot)

=

200 1 100 1

2

We may also say that the reward has a 2 to 1 ratio with risk, that is,

R/r 2:1→

From the equation, we observe that the lotsize cancels out. This means that the

R/r ratio is independent of tradesize. We can therefore visually gauge the R/r ratio

of any setup just by measuring the distances of R and r on the charts.

the term structure Characteristics

of reward and risk

The function of a stoploss and take profit varies with the time horizon. The stop-

loss has six basic functions, namely:

1. It limits loss by exiting a position if price moves adversely by a specified amount.


2. It limits profit by exiting a position should price move adversely by a specified
   amount before reversing back in a favorable direction.


3. It limits profit by allowing a position to momentarily experience unrealized
   profit before reversing back and triggering or taking out the stoploss, hence
   exiting the position.


4. It acts as a trailing stop, locking in profit as price moves in a favorable direction
   until price reverses back and takes out the stoploss, forcing the exit of a position.


5. It acts as a buy and sell stop entry order, allowing traders to enter in the direc-
   tion of the existing trend.


6. It acts as a buy and sell limit entry order, allowing traders to enter in the op-
   posite direction of the existing trend.

As we can see, the stoploss acts as an exit mechanism for four out of six

functions. We also see that three out of four exits function as a loss‐exit mecha-

nism, locking in short‐term losses. It has only a single function that operates to

lock in profit, that is, as a trailing stop. Therefore, all things being equal and

assuming that the markets are somewhat random, the stoploss will function as

a mechanism for locking in losses over the short term. Over the longer term a

stoploss acts more like a stop profit mechanism, since the majority of its exit func-

tions act to limit the possibility of allowing a position to remain in the market

long enough for profit to develop. Hence, limiting the maximum losses allowable

over the short term may well result in the accumulation of minimum profit over

the longer term.

The take profit order has also differing characteristics over the short‐ and

longer‐term horizons. Taking the recommended minimum profit over the shorter

term puts the system at risk over the longer term. This is because with fixed exit

levels, positions are not allowed to experience profit beyond a profit target. This

essentially shuts off any possibility of experiencing larger profits within the system