💡 Now that you have a plan on what style of trading you will use to pass your challenge, it’s time to understand how Risk to Reward is one of the most important aspects to becoming funded with prop firms.
As a trading enthusiast, I've used software to run simulated prop firm challenges with mechanical trading strategies, testing every possible risk-reward ratio (RRR) level. By running thousands of simulations, I aimed to determine the approach that creates the highest base probability of passing the challenge.
Let's first discuss the industry average for passing the first step of a prop firm challenge. If a customer buys a two-step challenge with a Phase 1 target of 10% profit and an overall drawdown limit of 10%, the probability of passing that first phase blindly should be 50%.
However, the industry average for retail traders to pass the first step is only around 10-15%. This is a startling statistic! How can a blind monkey pressing buy or sell be able to achieve a 50% pass rate with the right risk setup, while experienced traders struggle?
The root cause lies within the RRR and a pure neglect for strategic risk management. Retail traders often approach prop firm challenges the same way they manage a live account without any drawdown conditions, using strategies with high RRR because that's what they've learned. However, prop firm challenges are a completely different game from live trading. It's like trying to play football the same way you would play basketball - it’s just a completely different game.
High RRR strategies generally have high drawdown periods, but can still be profitable over time because the big wins eventually make up for the smaller losses once a big trending move is caught. However, the big issue with this approach in the context of prop firms is that drawdown is the number one thing you must avoid. Therefore, high profit, high drawdown strategies are TERRIBLE in a challenge setting.
So how do we go from the industry average of 10-15% to at least a 50% pass rate? That's a 400-500% improvement over what the average retail trader achieves!
The solution is deceptively simple: if you only take 1 to 2 RRR trades while using a proper stop loss (SL) range based on the Average True Range (ATR) indicator (as discussed in the previous chapter), you will significantly increase your odds from the industry average. With a decent entry model for your strategy and risking 1.7% per trade idea, you can achieve remarkable results.
With this approach, you will hit the challenge targets like never before, especially if you're a trend trader and your asset is trending. A good win streak can propel you to success.
Why is 1.7% risk per trade the optimal choice? It allows you two trading opportunities per day while staying far from the 4% drawdown limit. It prevents you from being flagged for high-risk trading, yet it's enough to gain substantial profits on the account when you hit a 1:2 RRR win.
Here's the strategy to follow: