Trading Strategy #1 - 3 Ways To Manage Risk
1 - Low Risk:Reward Ratio but a High Win Rate
This type of risk management strategy means that you will have small winners, but you will have lots of them.
A single bad trade will often wipe out the profits from a multiple number of good trades.
This is the type of strategy that most new traders implement. They like to see their statement full of green so take many profitable trades before they should. They also can’t handle taking the loss so let the single bad trade run deep into the red.
I would NOT recommend implementing this strategy.
Example: Your risk management strategy has an average profit of $100 and an average loss of $200, but 75% of your trades are winners.
Average Expectancy = (75% x $100) – (25% x $200) = $25
2 - Average Risk:Reward Ratio and an Average Win Rate
This type of risk management strategy is exactly what it implies. Average! If you’re implementing this strategy, you can expect to have roughly the same amount of winners as losers.
Your account will go up for a bit, then it might go down a bit and in the end settle back where you began.
If you implement this strategy then you can’t really expect to make money. It’s 50/50. Flip a coin.
This is where traders end up right before they are profitable. Do not quit! You are close.
Example: Your risk management strategy has an average profit of $100 and an average loss of $100, while winning 50% of the time.
Average Expectancy = (50% x $100) – (50% x $100) = $0
3 - High Risk:Reward Ratio but a Low Win Rate
To the normal human brain, this type of risk management strategy just sounds wrong. You lose more than you win and still make money?
But with just one winning trade, you can make an entire month’s profit. No matter how many trades you’ve lost in the lead up!
This is the type of risk management strategy that professional traders employ. They fight against every human emotion that wants to win every time and cut their losers short while letting their winners run.
Example: Your risk management strategy has an average profit of $1000 and an average loss of $100, but only 25% of your trades are winners.
Average Expectancy = (25% x $1000) – (75% x $100) = $175
No matter what your normal human emotions are telling you about winning more than you lose, DO NOT LISTEN TO THEM.
Make the right choice when it comes to risk management strategies.
Peace!
The @forexbrokr Trading Strategy Series
Instagram: @forexbrokr
Website: www.forexbrokr.com
thanks for the input.
Input lol.
GM! A very useful tool for testing risk parameters and maybe one you can mention in your articles is the Equity Curve Simulator. Few tests and and it's instantly clear, which strategy is sustainable and which is not.
http://www.equitycurvesimulator.com/
Nice little tool. Thanks for sharing!
"No matter what your normal human emotions are telling you about winning more than you lose, DO NOT LISTEN TO THEM."
I agree %100 with this statement, i have been trading for about 15 years now and i still have trouble with my discipline. As each year passes i make small changes to my trading plan, sometimes good , sometimes bad. Sometimes profitable trading plans stop working for a while for no reason.
But risk management and self discipline in my opinion, are by far the two most important parts of trading (live to fight another day ).
Good post.
Thanks mate.
We're all in the same boat battling against our emotions here. Some people call having the ability to switch normal human behaviour on and off being a psychopath... we just know it as trading :)
Have a great day!
great post, thank you for sharing :)
You scummy little spammer.