Planning Reward Targets Honestly: Probability Before Ambition

[Fairman]

Planning Reward Targets Honestly: Probability Before Ambition

A target of three times the risk looks attractive. Whether it is realistic depends on how often price actually gets there.

diagram.png (37.17 KiB) Viewed 23 times

Estimate the probability. If your setup reaches 1R about 60 percent of the time, 2R about 35 percent, and 3R about 20 percent, the expectancy of fixed targets differs. With a 1R target and a 1R stop, a 60 percent hit rate gives an expectancy of 0.2R. With a 2R target and a 35 percent rate, the expectancy is 0.35 times 2 minus 0.65 times 1, or 0.05R. With a 3R target and a 20 percent rate, it is 0.2 times 3 minus 0.8, or negative 0.2R.

So the most ambitious target is not the best. The target that maximizes expectancy depends on the distribution of how far trades go in your favor, which is why MFE data is useful.

Structure also matters. Targets placed just before significant levels have higher hit rates than those beyond them.

Combine with the costs: after spread, each of these expectancies is slightly lower.

Use your own data. After thirty or forty trades per setup, compute the share reaching 1R, 1.5R, 2R, and 3R, and pick the target with the best expectancy, avoiding overfitting by choosing a round number.

Revisit periodically, since conditions change.

Practical step: calculate the share of your last forty trades that reached 1R, 2R, and 3R at any point.

[Fairman]

The example shows it nicely: the 3R target looks the best on paper and has the worst expectancy. The chart doesn't tell you that, only the hit rates do. Running the numbers: 1R at 60 percent gives plus 0.2R, 2R at 35 percent gives plus 0.05R, and 3R at 20 percent gives minus 0.2R per trade. So the trader holding for the big target is losing money on a setup that's profitable with a closer target. A mixed approach can also work, for example taking half at 1R and leaving half for 2R. Run that through the same hit rates before assuming it's better than a single target.

[Fairman]

Placing targets just before obvious levels rather than at them is a small change that bumps hit rates. Everyone else's orders are sitting right on the level. If resistance is at 1.1000, a take profit at 1.0995 or 1.0990 gets filled more often than one at 1.1000, because price frequently stalls a few pips short when sellers there start working. Also remember your long target triggers on the bid, so the spread works against you there too. On a 40 pip target, giving up 5 pips costs about 12 percent of the reward. Check your own MFE data to see how many trades got within 5 pips and reversed.