Lessons

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What is the ​Risk Reward Ratio? (Simplified)

Complete Cryptocurrency Trading Course

Before you open a trade, the first thing you have to think about is whether is the risk you pay for the opportunity worth it.

In the real world, you will never risk losing $2 to get a dollar.

What you would do instead is to risk a dollar to get $2, right?

This is the first thing you have to consider doing.

The risk you are paying for the opportunity has to be worth it.

You do not want to be in a trade that doesn’t have enough potential.

Accept that you will be losing some trades and focus on lowering yours loses as much as possible.

Also, focus on trading when there is an opportunity in the market. Make sure that the risk of exposing the money to the market is worth the opportunity you are getting. 

How to make a system that will make you profit even when you are having losing trades?

Let’s us casino as an example.

The casino is the place where you bring your money to try to win some money and have fun.

The casino created a system where they will win no matter what will be the outcome of the next game.

The system has positive efficiency for them, and that’s why they always win. 

What is positive efficiency?

It is the expected return after a big number of games.

If it is bigger than 50%, it means that you will end up in profit after a big number of games. How many games is a big number?

Well, if you play 10 games, you can have a streak of 10 wins or losses.

So, 10 is definitely not a big number.

If you play 1000 games, the streak of 10 wins or losses is not going to affect a lot final results.

So, in some cases, 1000 is a big number enough to get expected efficiency.

What about 1 000 000?

There are thousands of players in the casino that are playing every day.

So, it is clear that they have big number enough.

Now, it is the question, how do they manage to get positive efficiency?

Let use roulette as an example.

The wheel has 18 red and 18 black fields. Most people think that they have 50% chances to be right, but most of them forget about two green fields (0 and 00).



So, let’s see what is the probability that you are going to win.

It would be the same if you chose red or black.

Let’s use red as an example.

If you place your bet on red, 18 red fields may bring you a win. On the other side, there are 18 black and 2 green that will make you lose.

Your chances are number of reds/number of all fields = 18/( 18+18+2 ) = 18/38 = 0.474 * 100% = 47.4%.



It is clear that your chances are lower than 50%.

The casino’s chances are bigger than 50%.

They are 100% – 47.4% = 52.6%.

Casino has 52.6% – 47.4% = 5.2% more chances than you.

If you play 10 times, you still have a chance to win in overall because nothing stops you from making 6 or 7 wins or even 10 wins.

If you are lucky, you will make it happen. 

But if you play 1000 times, chances are not in your favor definitely.

That’s why they will offer you drinks, food to play more because every bet you make is making them closer to positive efficiency.

Why there are no watches in the casino, why there are no windows?

They created an environment where you lose time orientation and your only focus is on playing the next game. 

The less time you play the more chances you have if you rely on luck.

That’s why beginners in trading may have a winning streak but it doesn’t mean they’ve mastered the craft.

In long-term, the winners are those who focus on creating a strategy with positive efficiency and sticking to that strategy until the big number of trades is reached (in trading even 100 trades is considered a big number). 

In the casino, if you bet a dollar, you can either win a dollar or lose a dollar.

You are either right or wrong.

In trading, we have ability to increase our potential win.

We avoid betting dollar for dollar but instead increase the potential of a win. We like to bet a dollar for $2 or even $3. 

It means that in trading we have the ability to outperform the casino if we follow not the rules someone else prescribed but the rules we wrote down when we were building our strategy.

 

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