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1987issue C021-4

Precommit the stop and require a surplus payoff

Selection can identify candidates, but the book is governed by a predetermined stop-loss, a surplus payoff when winners and losers occur equally often, and a pre-trade checklist written before capital is committed. A win counts only as a realized objective after proceeds are taken.

  • Technical or fundamental selection can identify candidates but cannot, by itself, produce a consistently profitable book. A governing process for losses and exposure is required.
  • Each selection has a predetermined amount of money at risk, commonly framed as a 10, 15, or 20 percent mental stop, and the planned stop is not widened or cancelled after entry.
  • If winners and losers occur equally often and losers are cut at 10 percent, winners must return substantially more than 20 percent for the book to stay ahead.
  • Capital is divided into limited probes. The failure mode is a large loss or an all-in bet on a single victory.
Entries in this reading3 entries
Current trackRisk-reward ratio78 readingsPre-trade checklist245 readingsStop-loss order297 readings

Selection still needs a loss process

Technical or fundamental selection can identify candidates. It cannot, by itself, produce a consistently profitable book. A governing process for losses and exposure is required.

The campaign goal is net success across engagements, not winning every trade. Some losing selections can still leave the book ahead if losses stay bounded.

A predetermined stop-loss

Each selection has a predetermined amount of money at risk, commonly framed as a 10, 15, or 20 percent mental stop. After that level, an engagement that fails from the start is closed.

The planned stop is not widened or cancelled in the hope that an adverse move will reverse. A stop-loss is a predetermined percentage or price at which a losing position is closed so planned risk is not enlarged after entry.

The risk-reward ratio for a mixed book

If winners and losers occur equally often and losers are cut at 10 percent, winners must return substantially more than 20 percent for the book to stay ahead. The required gain rises with the size of the risked objective.

The risk-reward ratio is the comparison between the loss accepted if an idea fails and the gain required for a mixed sequence of outcomes to stay ahead on balance.

A realized objective

When a target is reached, the objective is reviewed rather than automatically extended. A winning result is not treated as complete until proceeds are realized. A realized objective is a winning result counted only after proceeds are taken and the position is no longer exposed to a reversal.

The pre-trade checklist

A pre-trade checklist is a fixed sequence of decisions made before capital is committed: how much to risk, where to exit if wrong, what payoff is required, and when to stand aside.

Editorial note: apply that same sequence after the fill. The stop, the required payoff, and the decision to stand aside stay as they were written before capital was committed.

Probe allocation and the failure mode

Capital is divided into limited probes rather than concentrated. Names under 10 are treated as more erratic. Names above 45 are treated as slower to deliver large percentage moves.

Probe allocation is a limited share of capital used to test whether a suspected opportunity is real instead of committing the full account at once. The failure mode is a large loss or an all-in bet on a single victory. Positions are treated as calculated, bounded risks rather than a gamble of the whole force.

Educational research material, not investment advice. Historical source context does not establish present-day performance.
1 of 27 in the Risk-reward ratio track
19871-4 pp.Next on Risk-reward ratioWhen open losses overwrite precommitted exit rulesAfter a purchase already underwater by transaction costs, a falling position can be held by comparing each new decline with money already gone and by treating further decline as unlikely, until only a small fraction of the original outlay remains.
All readings on this track · 27 readings
  1. 1987Precommit the stop and require a surplus payoff
  2. 1987When open losses overwrite precommitted exit rules
  3. 1991Ranking month-end holds with risk-reward and stops
  4. 1994Evaluating percentage profit exits on trend-following averages
  5. 2001Construct reward to risk before entry
  6. 2003A pre-trade readiness checklist for entry, abstention, and risk
  7. 2003Evaluating out-of-the-money strikes with saddle premiums and implied volatility
  8. 2004A critique of one-procedure trading decisions
  9. 2004Mechanical stops leak intent and misprice losses
  10. 2004Implied-volatility premium on rate indexes
  11. 2006Keep the stop that authorized the entry
  12. 2006Bound the loss with a risk-to-reward filter before entry
  13. 2007Audit the operator before abandoning a system
  14. 2007Failed-break slingshot reversal rules
  15. 2007A system-management template that sets the stop and the required reward before entry
  16. 2007Construct a pre-trade style envelope for entries and skips
  17. 2008Systems that skip the three decision gates
  18. 2010Four-gate veto before trend entries
  19. 2012Construct a trading plan as one written procedure
  20. 2012Forex stops and reward targets by quote increment
  21. 2013The average directional index as a lookback cluster and a risk-reward bound
  22. 2014A three-step worksheet for VIX futures tick value and low-vol risk-reward
  23. 2014Binary option premia, fees, and pre-expiry risk-reward
  24. 2015Selling far out-of-the-money commodity option premium as a forgiving timing case
  25. 2016Prepaid option spreads that bound range-day risk and reward
  26. 2016Pre-trade risk-reward versus instinctive exits
  27. 2020Bounding a short-dated option spread with a stop, a gap remainder, and a credit exit
By fieldStops and loss limits76 readingsBy year198741 readings
All 78 readings tagged Risk-reward ratio
Also on Risk-reward ratio5 readings
1995A pre-trade checklist that bounds loss before the order2003A pre-trade readiness checklist for entry, abstention, and risk2007Audit the operator before abandoning a system2007Construct a pre-trade style envelope for entries and skips2008Systems that skip the three decision gates