Do you keep tabs on your trades all of the time? Do you know how much danger you are willing to take in exchange for a reward? If you answered yes, you have already outperformed 90% of all traders. That is great! Understanding the risk-reward ratio is the first step to making your crypto trading risk low. If you are unfamiliar with the risk-to-reward ratio, this article will be beneficial for you.
The risk-reward ratio is the amount of potential profit you can make for every dollar you risk. Assume I have a risk-to-reward ratio of 1:2. It means I am willing to put up $1 in exchange for a $2 payoff. At a 1:4 risk-reward ratio, I would risk $1 for a potential payment of $4. It is straightforward. Right?
Traders utilize a 1:2 risk-reward ratio as their optimal risk-reward ratio. For a one-dollar risk, you can make a two-dollar reward. This option, according to most skilled traders, is the best risk-reward ratio. However, there is a disadvantage to utilizing the risk-reward ratio. Why is it the case? Let us have a look.
Assume you trade ten times and employ a risk-to-reward ratio of 1:2, which is the industry standard. However, you only have a 20% success percentage on the ten deals you make. It means that out of ten trades, there are eight losses and two wins.
Your total gain will be $4, and your total loss will be $8 because you employ a 1:2 risk-reward ratio. There is a net loss of $4. This case is a no-win situation. So, what is a trader to do? Is it necessary to have a higher risk-to-reward ratio, such as 1:5, to be profitable? No! As a result, the risk-reward ratio will not suffice. You must also have a high win rate. Even if your risk-to-reward ratio is 1: 1 or 1:05, if you have a high win rate, you will be successful in the long run. However, win rate alone will not work; risk-reward and win-rate must be combined. You need to merge these factors to determine whether the technique you are employing is successful in the long run.
This point is where expectancy comes into the picture. According to Investopedia, “Expectancy” or “Statistical Expectancy” pertains to the average amount you might expect to win or lose per trade. The formula for expectancy is this: E = [1+ (W/L)] x P – 1. The letter E stands for Expectancy, W for Size of average win, L for Size of average loss, and P for Winning rate or percentage. Let us have an example so we can better understand this concept.
Assume you’re keeping track of all your trades. You make 50 trades, 30 of which are profitable and 20 of which are not. This figure is reasonable because no trader can guarantee a 100% win rate. So, let’s keep going. If you have 30 profitable transactions out of 50 trades, your winning rate is 60% (30/50). And if you make a profit of $2,000 on 30 deals, the average we’ll get is $333. In your losing trades, say you lost 20 times with a total of $ 1,200. The average that we can get is $300.
We can get 0.26 or 26 per cent if we use the given figures in the formula. In the long run, this suggests that your trading method has a positive expectation of 26%. In other words, a $1 risk every trade will yield a $2.60 return. We only estimated 50 trades in our case, which is a very small number. It would be great if you could calculate 200 trades instead of 100.
A positive expectancy will tell you how effective the trading method you’re applying is. Positive expectation, according to Stator, is the amount of money we may expect to make on average for every dollar we risk.
You might ask: what is more important in trading? Is it the risk-reward ratio or the win rate? Good question. But the answer is none of them. The most important is positive expectancy. Do traders you know do this? No! 90% of traders do not know about positive expectancy. They are very focused on technical analysis, win rate, etc. If you know your win rate, risk-reward ratio, and expectancy, you are ahead of 90% of traders out there. If you are not tracking every trade you make, maybe you should start now because you can’t apply it if you do not record all your trades.
You might ask, in trading, what is more crucial. Is it the victory rate or the risk-reward ratio? That is an excellent question. The answer, though, is none of them. Positive expectation is the most vital. Do you know any traders who do this? No! Positive expectation is a concept that 90% of traders are unaware of. They place a high value on technical analysis, win rate, and other factors. You are ahead of 90% of traders if you understand your win rate, risk-reward ratio, and expectancy. If you aren’t monitoring every trade you make, you should do it now because you won’t be able to apply it unless you do.
This strategy requires a lot of effort and computation. It is tiresome. Yes, that is true. But remember, it is essential in trading. It is also important to note that too much focus on balancing profit/loss ratios or on the accuracy of their trading approach might result in what experts call analysis paralysis. Remember, everything that is too much is bad. Balance is essential in whatever we do.
Instead of dwelling too much on the technical side of trading, some beginners seek assistance from professional crypto traders, check out Bitcoin Pro and start today. There are trading platforms that provide newcomers with access to the most reliable brokerage services. It is a smart move since there will be experts alongside them to guide them in making decisions. Remember that patience is very crucial in the crypto world that is risky and volatile. For this reason, traders exert effort in conducting in-depth research about the industry before they start trading.
