Risk to reward calculation
Welcome to this educational idea about the risk-reward-calculation in position trading with the 5-Key-Components determined. Today's markets constantly changing and adapting and in such environments, we need to stick to a systematic trading approach to have the long term goals realized and do not fall apart of market-making and smart money operators, when considering position-trading there are some important steps in acquiring the long-term-success we should take apart when calculating the right risk in comparison to our capital and other key-steps to measure what trading is the best for ones individual trading-system to achieve the aims we desire. Therefore I contributed the 5-Key-Components inevitable to measure one's risk-to-reward in the market and best applied in a functional trading-system. 1.) The 5 Key Position-Trading Rules 2.) Acknowledging Risk Aversion 3.) Risk-To-Reward-Calculation 4.) Risk-Reward-Ratio vs. Winrate 5.) Possibilities of Success and Ruin
1.) The 5 Key Position-Trading Rules 1. First Rule: Do not hold the position longer than necessary: It is important to choose a trading-system which has good entry timing and the right opportunities to exit therefore it is the best to be in the market when volatility increases and takes profit at the important levels to not hold the position unnecessarily longer. 2. Second Rule: Aim to make as much as possible by risking as little as possible: When trading we should advance by making the most of what we have at hand, today's markets offer options with leveraged trading which can work also with smaller percentages of the deposit at hand, in this case, the leverage should be calculated right. 3. Third Rule: Only risk a small amount of capital on any trade executed: It is commonly under beginner traders to risk a high percentage of the total deposit, this is a fatal mistake as the risk grows exponentially, to achieve security of the deposit in the long-run, the maximum risk per trade should not be more than 10% from the deposit, best is 0.5-2%. 4. Fourth Rule: Don't come to the situation to meet margin calls: This means you should avoid being marginally called on any occasions, when this happens there is evidence that the trade was too risky and the stop-loss better be placed before the margin call, when it happens, it should be a time to review your trading-system. 5. Determine the maximum drawdown for every trade in advance Before every trade you should measure how your position size with the stop-loss will possibly take a drawdown in the deposit. When the risk is too high then the smaller position should be preferred, when it is still too risky than a bigger account will be a good option.
2.) Acknowledging Risk Aversion This is a very important step in determining ones individual trading-systems, as traders act differently to circumstances some traders are risk-averse and others are risk-seeking, this means how the trader is reacting to risk and how much the individual would risk receiving a return. In the graph, you can see that the lesser your capital is the higher your risk-seeking, you are more ready to risk something averagely when your capital is lower, this diminishes the higher your capital is, there are different risk preferences reaching from extreme risk averter to extreme risk seeker.
3.) Risk-To-Reward-Calculation In the big table in my chart you can see the risk-to-reward calculation and the values in it, the first value is the risk meaning how much you want to risk in the particular trade coming to the second value, the return is what you get in return on your trade. For example, you want to buy bitcoin at 15000 and have set the target at 15010, by the technical analysis you have determine a stop-loss at 14500, this will be a highly risky trade as you are risking to lose 500 points comparison to 10 points. The best trades are in the green section on the table beginning with trades where you gain 2 and risk 1, these trades should be the aim and preferred, the breakeven ratio determines how much trades need to go in breakeven to be long-time profitable.
4.) Risk-Reward-Ratio vs. Winrate This rate is showing you how your trading develops by time, when you have a good winrate this means you are closing many of your positions in a profit on the other side when this winrate is low you closing too many positions in a loss and often be unprofitable in the long-run. What determines an excellent trader now as it is marked in the chart is when the average risk-reward ratio is high and the winrate also, this means you close many of your positions in a profit and also with the proper risk-reward-ratio. On the middle of the chart is the threshold determining low and high, you can also be profitable when your risk-reward is high and your win rate low or in reverse, what should definitely be avoided is when both the winrate and ratio are lows this means you have to adapt your trading-system for sure.
5. Determine the maximum drawdown for every trade in advance This is a simple but very effective and important graphic showing the likelihood traders have for a point of ruin and how much the risk of ruin in comparison to it is, meaning when your deposit is at a level on which there is no longer possibility to continue. This graphic shows that when your capital is more your risk of losing it diminishes, on the other side when it is low the possibility for losses is more as the capital is not big to stand the losses, this is a groundstone knowledge in determining the trading-system together with risk. The graphic shows that the higher your deposit is the better you can take the risks in comparison and the lower it is the higher is the risk of losing more, this is why it is important to combine the risk together with a solid portfolio.
Last modified 5mo ago
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