#59 - Importance of Risk:Reward
Hello everyone! Got some educational content coming your way which lies at the core of trading concepts and it is something that should always be considered when entering a trade:
In general, you should aim for a Risk:Reward Ratio (RRR) greater than 2 because with a 2:1RRR you expect to lose half of the time when you enter a trade. Keep in mind that you can win more often than half of your trades with a RRR of 2.
However, there is nothing you can do about that. All of your work should be put prior to enter a trade; there should be very few (adjusting your stop loss is a common one) to no changes during your trade.
To see exactly how this works let's see an example which was seen on Bitcoin. Below you can see a HVF setup which formed on the right shoulder of the inverted head and shoulders pattern back when Bitcoin bounced from 6k.
If we zoom in a bit, in the picture below, we can see that the RRR was 5.62, a rather high ratio which I would personally take everyday.
The way the RRR is calculated is by taking the distance from your entry (in our case at the green dashed line) to the target set by the blue dashed line and dividing by the distance from our entry to our stop loss level (the red dashed line).
Your stop loss is the level where you consider that your trade went wrong and you cut your loss short. Nothing wrong with that. Part of the game.
The most common mistake is that this stop loss level is rarely set or you set one but decide to ignore when it gets to the time of cutting the loss. Both of these are not helpful long-term because the lack of discipline will just get you burned over time. It might work a couple of times but eventually, this behavior will be revealed by the market.
The problem with not trading with a stop loss is that you are not able to find your RRR without it. The same goes for not setting a target. Besides your entry point, you want to consider both your take profit area as well as your stop loss level so you can find that RRR.
One should always attempt to improve the RRR. If we take a look at the picture above we see that our entry and stop loss levels haven't changed from the previous image but our target has: it is now the measured move from our inverse head and shoulders.
In turn, our RRR is greatly improved to 13.81. This means that we need to win this trade about 7% of the time which is rather low and good for whoever takes a similar trade. This trade turned out to play out to that level. Below you can see the progress, reaching our first target:
In case you don't have no clue of what a HVF is, check out the post where I go over the basis of HVF Theory and what characteristics of price behavior I am looking for on a chart:
https://steemit.com/trading/@beindependentbb/19-what-is-the-hunt-volatility-funnel-hvf
Disclaimer: Cryptocurrency trading is highly speculative in nature which can mean currency prices may become extremely volatile. Cryptocurrency trading carries a high level of risk and may not be suitable for all investors. It is possible that you will sustain a loss of some or all of your initial investment so never risk capital that you cannot afford to lose. You acknowledge and agree that no promise or guarantee of success or profitability has been made between you and BeIndependent [bit by bit].
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