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The CRV, as the name suggests, indicates the ratio of opportunity to risk. It is one of the fundamentals of risk and money management, which, as every trader knows, is the foundation for long-term stock market success. As hedge fund manager Larry Hite has already correctly said: “I do not see the markets; I see the risks, opportunities and money “.
Potential risk: the difference between the entry price and the stop-loss
Potential opportunity: Difference between the entry price and the take profit.
If the quotient between the potential opportunity (profit) and the potential risk (loss) is calculated, the CRV is obtained.
For example, if the potential profit is 20 pips and the stop-loss is 10 pips, you have a risk/reward ratio of 2:1, which means that the potential profit is twice the potential loss. So in case you win, you get two euros back for every euro you bet.
An example of the risk/reward ratio using GBPJPY
For example, let’s take a trade in the GBPJPY currency pair.
We go short in GBPJPY. The entry signal in this example is a bearish reversal formation, namely the Bearish Harami. This is formed at the 50 Fibonacci level. The entry then follows the formation of the Bearish Harami, e.g. at the 38.2 Fibonacci level. The stop is placed above the resistance with some distance to the entry, e.g. at the 61.8 fibo level. The target (price target) is then the next support, which in this case is the 0 fibolevel.
- Potential opportunity: Target (142,275) – Entry (142,351) = 7.6 pips
- Potential risk: Stop Loss (142,397) – Entry (142,351) = 4.6 pips
- CRV = Potential opportunity (7.6) / Potential risk (4.6) = 1.65
- So this trade offers a CRV of 7.6:4.6 and 1.65:1 respectively.
Why the CRV alone does not work
However, many traders make it too easy for themselves. In many books you will often find the recommendation not to enter into trades with a chance/risk ratio of less than 2:1 or even 3:1. Any book that contains this recommendation can be thrown in the trash bin and also shows why that person wrote a book about trading. This is because that person probably did not understand trading and therefore has to earn his living by writing books instead of trading successfully himself. A CRV alone has no meaning whatsoever.
Likewise, it is unrealistic to simply always take a CRV of 10:1. It sounds nice that the profits are theoretically always 10 times the risk, but the question is how realistic is this? How many of you have ever made a trade with a CRV of 10:1? And if so, how often?
There are no good and bad CRV’s
It is therefore a myth that there are good and bad CRV’s. Whether a CRV is useful or not can only be clarified with the help of the hit rate.
It is also a mistake when traders plan a trade and simply expand their target and/or reduce the stop loss in order to obtain a supposedly better CRV. In theory, you get a better CRV, but how often do you get it in practice? Similarly, it is a mistake that some traders think it is easy to make up for a loss trade by simply increasing the target on the next trade. Trading is not pure mathematics, that would be too easy. It is a game of probabilities. So is the CRV. You have to know the probabilities of your trading system.
CRV in combination with the hit rate
If you take a closer look at your trading strategy, you will quickly get a feeling for a realistic CRV and can therefore very easily calculate the required hit rate or the expected risk/reward ratio. The formula for calculating the minimum hit ratio, i.e. trading at break-even, looks like this:
Minimum hit rate: 1 / (1 + CRV)
If you know your hit rate, you can use the following formula to calculate the required risk/reward ratio to at least break even:
Required CRV: (1 / hit rate) – 1
The graph shows that with a CRV of 1.5, a hit rate of 40% is sufficient to break even.
The simplest example, of course, is a CRV of 1, so you need a hit rate greater than 50% to be profitable and 50% to break even.
Let’s assume that our system generates 100 trades per month and we have a CRV of 1, the hit rate is 50% and we risk 500€ per trade.
Then the total profit per month would be 0 €, as you can see from the following formula (number of trades * hit rate * risk per trade * CRV)
profit trades – loss trades
(100 * 0,5 * 500 * 1) – (100 * 0,5 * 500 * 1) = 0 €
With the same hit rate, but a CRV of 1.5:1, the trader would make a total profit of 12,500€ with the same risk and number of trades:
Profit trades – Loss trades
(100 * 0,5 * 500 * 1,5) – (100 * 0,5 * 500 * 1) = 12.500€
What is the difference between CRV and R-multiple ?
They are quite similar. Usually the difference between the entry and the stop loss is 1 R.
This means that this is the maximum amount you want to risk per trade.
In the example above, this was 500€. If you make 1,000€ with just one trade, then the trade had 2R (1,000€/500€). The same goes with pips or points.
If you say the initial risk was 10 pips and you earned 18 pips, the trade was 1.8R (18 pips/10 pips).
R multiples therefore always refer to the initial risk.
The CRV is more of a potential performance measure, while R-Multiples describe the current performance. In principle, however, both have the same goal, and therefore one can only work with R-multiples, as this can also be taken into account in trade planning.
So I only work with R-Multiple. But the important thing is that you plan your trades firmly in advance and therefore always know how high the risk per trade is and how you define it. One of the key principles in trading is that every time you open a position you know in advance when you are ready to close it again. On the one hand, when it is running for you, and on the other hand, when it is running against you. You should therefore have played through all the scenarios in your head in advance and know exactly where you are going to do what.
Tool for determining the CRV
To have my risk/reward ratio always calculated automatically, I use the CRV tool from Tradingview.
Here you have the ingenious possibility to have the CRV displayed.
You can also choose how much of the current trading capital you have and what percentage should be risked per trade.
I think the tool, as well as Tradingview, is simply ingenious.
For a long trade, you can simply have the CRV determined using the Long Position tool, for a short trade using the Short Position tool.
Here we see an example on a daily basis.
Entry is at 1.21121, when after the trend break the trend line is touched again at the support. Additionally, there is a positive candlestick formation before (in this case a doji and a green confirmation candle).
We place the stop at the last retracement low at 1.19919.
The target is the next resistance in the daily range at 1.23720.
The trading capital is €10,000 and the risk is 1% per trade.
TradingView therefore shows an amount of €9,900 at the stop. This would be our trading capital if the stop loss is reached.
On the other hand, the trading capital would be €10,216 if the target is reached.
The CRV is also calculated automatically. In this case this is 2.16 (opportunity: 0.02599, risk: 0.01202 => CRV = 0.02599/0.01202 = 2.16).
The profit would therefore be 216 € (100 € Risk x 2.16).
Although the CRV alone is not meaningful, it is one of the fundamental components of trading. Because you should plan every trade before you make it. This also includes the risk/reward ratio. Because the only component on which you always have an influence in trading is risk.
Together with the hit rate and good money management, this gives you a very good chance of trading profitably in the long term. That is why a discussion of the CRV is indispensable. George Soros rightly said: “It’s not a question of whether you’re right or wrong, that’s not important. It’s about how much money you make when you’re right and how much you lose when you’re wrong.”