Trading with Risk Reward Ratios, Managing Risks & Leverages.
#RISK REWARD#
There are many ways people take risks and define it, and there are many ways at which people approach risk management. Recently i heard someone saying a plan only is bad when the trade goes south, but is this really true? meaning there is no good or bad plan but once the trade goes bad then the plan is bad.
Hmm, as for risk management this is entirely wrong, we can chose to take different risks yes but some risk are greater than other while some risk wont have much effect on you when the trade goes south, then you will still be in pole control of the situation with minimal risk. Example if you decide to go all in on a trade because you believe the price is at support, and then you decide to not use stop loss, and your order gets filled and then breaks the support and keep going down like crypto did in early 2018, in a twinkle of an eye, your whole balance is halved like btc halvening lol. Even when you use stop loss, you still expose urself to bigger loss compared to when you really minimize the risk exposure.
Lets say you have a balance of 1k usd, and you use a stop loss of 10% on a trade, if your sl gets triggered you tend to lose 100$. Whereas someone can chose to risk just 20$ on the same trade in the case it goes south. Yes it is said the more you risk the more you make, that is correct but then it should not let us blindly take risks,
One thing to remember is capital preservation is a key factor in risk management, hence why traders stay flat when the see no good setup or when the market is in a whipsaw. Why do we look for good trade setups if not because we have a plan to enter at a point we believe the market will reverse and then we will be in profit, we can just chose to buy anywhere and expect the price to go in our favour and then enter all in, but NO we dont do this because we see that it is risky, not because we cannot do it but because it will be a risky and blind trade.
This works sometimes but also its a good way to rekt your portfolio most especially when you end up buying an asset just before reversal to the downside. someone who have all his funds on this trade will then keep hoping it goes back up but price will keep going down until the losses is too big to cut.
This will do one thing for you, it will tie you and your money down for as long as the market pleases, hence no way to make profit for as long as the market want, even when price returns to your entry, you become anticipative that price will go up the more for you to profit only for it to return back down putting you in a phase of pain, hence you see people tired of btc when it does the opposite of what they expect. But with a good risk management and plan, if the market goes against just, you basically exit with minimal loss and still preserve a majority of your capital and be able to take up another trade in anticipation of recovering.
This is why the use of Leverage is good, to help you and derisk your exposure while trading big money, people go all in because they want big money in a trade as they believe the bigger the money the bigger the profit. while putting all their risks and exposure on a trade, with leverage you can risk little and still trade with good and big money.
Greed is what is behind most motive of wanting bigger profits quickly and this greed is driven by pressure which we should not submit to. Someone with a damaged phone/laptop who really needed to replace the phone or laptop is being pressured by the fact and desire to replace the item and then forced into taking big risks in the market, where if it goes in their favour they get happy, but if it goes against them, what then happens? they blame it on the whales, manipulations and bla bla bla, can we still refer to this as trading? NO. We do say trading is a game of calculated risks and it is 99% risk management and psychology, because risk is driven by psychology as explained above. What such person did was purely GAMBLING and not trading.
You are not a traffic officer who tells when cars on the highway comes to a stop for others to pass, you do not control the market not anything in the market, hence you cant fully predict what the market will do, only thing is you can anticipate, when this is the case, why are you 100% convinced and sure that price will reverse at your entry for you to decide to go 100% in on your capital????
Let us proceed now to Risk:Reward and the use of leverage especially in margin or futures trading.
Before i start talking in maths, there are different ways people access risks.
Lets say we have a balance of 10,000.
Some people do say risk some % of your capital, there is always misconception here as most people take a % of their capital and put it to trade as their position size, this is not the proper way even though it is also part of, but not the best way to calculate your risk.
They take 10% of their capital and put it into a trade and then set stop loss based on this amount, 10% of 10k will be 1k, and if they set stop loss as 10% then thats 100$ to lose.
it is also a way to go about it but when someone says risk a % of your balance, it means the amount you are willing to lose. This is where the risk reward comes into play.
1:1 means for every 1 risk taken, there is possibility of equal amount of gain if the trade goes well
1:2 means for every 1 risk, there is possibility of twice gain. your risk is 1, and reward/gain is 2 times of that risk
1:3 means risk 1, gain 3. in other words and it continues like that.
What should be the minimum risk reward we trade with, this is a matter of personal preferences and what is OK with us, knowing fully well that the market can chose to turn at any time, this is the more reason to follow trades with extremely good risk reward and high probability(what looks best) and why having large stops is bad for risk reward ratios.
Lets take a look at 4 trades. (2 wins, 2 losses) all with the same amount of risk. Assuming we risk 50$ per trade, remember risking 50$ per trade doesn’t mean the amount we trade with, but the amount we can afford to lose incase the trade goes south
on a 1:1 ratio, say if the trade goes negative 1%, we exit with 50$ loss, it also means if the trade goes 1% profit, we exit with 50$ gain.
first trade, we win 50
second trade, we win 50
third trade, we lose 50
fourth trade, we lose 50
end of the day, no gain no loss.
if we add a fifth trade and win, then out of 5 trades, we need to win 3 trades and lose 2 to be able to profit on a 1:1 ratio, this is not good as your setup must be extremely excellent to be able to work with this ratio. what if you have a losing trade of 3 out of 4, or 4 out of 5? then you are in loss overrall.
1:2
first trade, win 100
second trade, win 100
third trade, lose 50
first trade, lose 50
end of day, won 200, lost 100, and overral profit of 100. unlike 1:1 that has no gain no loss.
if we add a fifth trade and win, then out of 5 trades, we need at least 2 wins to be profitable at the end of the day, even if the fifth trade is lost, he loses 50, which means total loss is 150, total win 200. 200–150 is 50. still profitable for the day.
1:3 or 3:1 or 3R as different people refer to it
first trade, win 150
second trade, win 150
third trade, lose 50
first trade, lose 50
end of day, won 300, lost 100, and overall profit of 200.
if we add a fifth trade and win, then out of 5 trades, we need at least 2 wins to be profitable at the end of the day, even if the fifth trade is lost, he loses 50, which means total loss is 150, total win 300. 300–150 is 150. see the difference now between 2R and 3R, both needs 2 win in 5 trades to be profitable but 3R offers more profit than 2R. as if you win 2 and lose 3 trades on 2R, your end profit is 50, whle on 3R end profit is 150.
hence the need for a favorable risk reward, the higher the R the higher the profit.
But because market can turn at anytime and due to the over extended zones as per crypto, most times there are good setup but risk reward is bad, because a trade may need to go about 20% at times for it to meet 2R talkless of 3R or 5R, and at times coinswill just do 5% and turn back down, not meeting your risks tolerance. Hence the reason to find zones with good risk reward setup and have good chances of hitting your 1:3 or 1:5 R asap with less struggle.
Also if you trade support and resistance and you buy at support, you want your 1:3R to be atleast before the next resistance line, if the 3R is above the resistance line, then you know risk factor wont allow you to take the trade as it hits resistance before your risk target, and price can turn at the reisstance line will may not even give you 1:1 ratio. and if we force this trade and lose, we blame ourself emotionally which will have a psychological part on our next trade.
Lets try and plan the trade and trade the plan, many many opportunity presents itself daily. no need to force a technically bad trade. except we want to keep buying more at dips that we have no idea where it will actually reverse.
Lets talk about the use of leverage now, this has ben said many times before so still going to say the same thing.
as you can see the distance of zone is a wide 20%, if you were to go all in on this lose and place stop loss 20% neg, thats a whole if price goes 20% against you and stopped out, you lose just 100$. thats where and why good plan is needed
now see the 2R is 40% away, 3R is 59% away, 5R is almost 100% away wow, willt his coin do 5R which is 100% growth with this btc happenings? i doubt, will it do 3R, maybe, will it even do 2R, maybe.
notice how the position of 2R and 3R are both point of resistance before
if we get a reversal from this zone, then we are more likely to visit those R but not without turbulences on the way, which can even bring price back to this entry zone and even deeper before it continues back up, in such case will you give back to the market this current 13% its giving you in profit?
and remember if you risk 50$ here, it means only when price travels 20% up before you can make that 50$. which means this current 13% profit is half of 1R, which means you are about 25$ up. greed will let some take profit, whole patience will let others wait till atleast 2R which is twice their risk and still OK.
but looking at all these market conditions with btc, will you even take this trade at all????
Now to leverages and risk reward
As for leverage, lets take 3 cases into account,
DrFamoo uses 100x of leverage.
MrKingsley uses 20x
MrKyrian uses 1x, which is same as NO leverage at all.
All 3 men have a capital base of 10,000
all 3 men uses same risk of 50$ per trade (which is 0.5% of account)
all 3 men uses a 5R risk ratio.
this setup means, if sl is at 1% negative, take profit will be at 5% positive.
Famoo takes a trade with 50$ as risk, hence having an initial margin of 50$ which is used to open the position, if liquidated, he tend to lose this 50$, but then if his stop is hit, he loses 50$, which means position of his stop loss is probably the same as his liquidation.
His position size becomes 5,000. (50 IM x 100x) = 5k. IM = initial margin
when the price goes up the expected 5%, you see his ROI on binance becomes 5% x 100 = 500%. But in reality he is making a profit of just 250$
Kingsley takes his trade with 50$ as risk, but with 20x hence his initial margin required to open the position will be 250$. He will lose this amount in the case of liquidation, see how 100x has helped Famoo to derisk in case of liquidation as he loses 50$, also notice how close to current price Famoo liquidation is as his liquidation is same as his stop loss. but Kingsley will lose 50$ to sl at dat price and only lose 250$ in case of liquidation at a much more lower price line.
His position size will become 5,000 (250 IM x 20x)
When price goes up the expected 5%, ROI on binance becomes 5% x 20x = 100%, and his actual profit becomes same 250.
you see all this 500%, 100% when actual move is 5% because the roi is based on your IM. you trade a size of 5k, and 5% of that is 250. but your initial margin is 50, and 500% of 50 is 250. and 100% of 250 is 250. so you get shown all those big % based on your actual money used for opening the trade and not the borrowed funds.
Now Kyrian uses no leverage as he has an averagely big balance, he depends solely on stop loss to actually work without slippage.
Hence Kyrian takes a trade with 50$ as risk, with 0 leverage hence 1x. No initial margin required as it is spot.
how much position size will he take that when it goes 1% against him he losses 50$? thats 5k. because 50 is 1% of 5k.
Hence his position size is 5,000. Same as Famoo and Kingsley.
He wont get to see big % but only the actual price change.
When price goes up the expected 5%, he will see 5% move and by then his profit will be the same 250 as Famoo and Kingsley.
The only difference here is that Kyrian used his money to sponsor the trade solely. He didnt borrow from anywhere where he will be required to pay funding fees at intervals. While Both famoo and Kingsley uses 50 and 250 as collateral to borrow the 5k, and put themselves at risk of losing that amount in view of liquidation.
Notice we have done a 5R setup here, you can also try for 3R or more or less.
if all men has risked 100$ instead of 50$, they will all have a end profit of 500$. Hence the risk of using leverage is not essential when you have decent capital and that amount is well within your risk tolerance.
So see that risk taken is of high priority than leverage used.
Hence why risk management determines your profit margin.
Someone can post 1000% roi, just ask the person what is your risk amount and what is the RR. Many dont even know but show you 1000% to gear your interest where in actual fact, it doesnt mean success or growth. seeing 1k% you will be way overhead thinking 1000% of 1million already, not knowing the otherwise.
So with this i have spoken about risk management, risk reward and leverages.
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