#RiskManagement #moneymanagement #training Hey, guys.
This is a continuation of the risk management guide, in which I have collected the most important aspects that allow you to trade in the plus side over the long haul.
In this part we will look at two more important components of risk management, see the first part in the linked post.
Part 2.
Risk to profit ratio.
The Risk/Reward (R/R) ratio is the amount that a trader can earn in a trade and lose.
Example.
You buy an instrument for $100, your target is $200 and your stop loss is $50.
What is your R/R for this trade?
R/R = (100-50)/(200-100) = 1 in 2.
Mathematical expectation of the trade and Win rate.
Win rate is our performance based on the previous statistics of trades made.
We all know the example of flipping a coin.
We flip a coin 10 times and get heads or tails 50% of the time, so our Win rate is 50%. We earn $5 every time a heads heads comes out right and lose $5 every time a tails comes out right.
Here the R/R ratio is ($5/$5) = 1:1.
After 10 rolls, the result = $25 (win) - $25 (loss) = $0
Suppose now that under the same conditions we get an eagle 60% of the time.
At the end of 10 throws the result = $30 (win) - $20 (loss) = $10.
Now, if we keep the original Win rate, but earn $10 on every eagle roll instead of 5, our new R/R ratio is ($5/$10) = 1:2.
At the end of 10 rolls, result = $50 (win) - $25 (loss) = $25
At the end of 1000 bets, the result = $5000 (win) - $2500 (loss) = $2500.
Now we can see that our Win rate is as important as the risk to profit ratio R/R, and they are not interrelated. For successful trading we don't need to be right in a trade 100% of the time, a 60-70% success rate is enough.
Stay tuned.