Understand the Risk vs. Reward Ratio You Should Apply to Effectively Manage Your Trades.
Discover the formula to trade efficiently and protect your capital by properly managing your risk. Risk vs. Reward Ultimate Guide, Learn How to benefit from stopping your losses.
Trading on the crypto markets can be risky, so you should understand the types of risks. Fundamentals like understanding and recognizing market trends and risk management are vital to your trading activity. If you don’t know the basics, you’ll end up hurting your account.
Without these basic concepts (your day trading or swing trading, either manual or with a bot), it will be too hard to protect or grow your trading account. Understanding market fundamentals such as those mentioned above will impact your investment and trading decisions.
The truth is that every trading system will have winners and losers, but what really makes the difference between traders that make money and those who won’t is that winning traders are willing to be wrong quickly but willing to be right for longer.
This article aims to explain in detail what risk management is in the crypto market. The objective is also to explain what the risk vs. reward ratio is. Both of these objectives are important in controlling your trading risk.
What is Risk Management?
Risk management is the rule used in controlling risk. An example of risk management is setting a stop loss/take profit. You must know that a trader should never enter a trade with a risk/reward below 1:2, and for beginners, I would recommend 1:3.
Trading cryptocurrency has excellent potential for reward but also great potential for risk. You must be aware of the risk and accept it. The best way to control risk is to establish your business rules.
A trading rule could be that you only want to trade at certain times of the day. The argument for this trading rule could be that you only want to be in the market when the market has volume.
Another rule of trading could be that you have a strategy that reduces losses. The method could cancel a trade if the loss is more than 5% of your account. If you have $3000 worth of BTC in your account and set the trading rule at 5% of your account, the stop/loss would be $150.
Setting up a stop-loss should limit the risk of a trade. It must reasonably limit the risks and be meaningful to you.
It is also essential that you stick to the stop/loss rule and do not start adjusting the stop-loss further because you think the exchange rate will begin to rise soon after breaking the stop/loss fixed.
What is a Risk vs. Reward Ratio?
The risk-reward ratio is also part of risk management. The emphasis is on how the reward relates to the risk in a trade.
Risk is the amount that you invest in a single transaction. The reward is the profit you expect to make from that trade.
If you risk $200 worth of BTC in a trade and the reward is $400 in BTC, the risk-reward ratio is 200: 400 and the same as 1:2. Likewise, if you risk $300 worth of BTC in a trade and the reward is $900, the risk-reward ratio is 300:900 and the same as 1:3.
The risk vs. reward ratio determines whether you should accept trade or wait for the next trade opportunity. The minimum risk vs. reward ratio is 1:2. In other words, if the risk is $20, the reward should be $40.
A risk/reward ratio of 1:3 would be $20 and a reward of $60. A good risk/reward ratio will allow you to get it wrong 50% of the time and stay profitable.
Let’s look at an example of ETH/USDT trading that follows sound risk management. We have determined that the overall trend is up, so we are looking for a long (buy) position.
We decide that we want to buy at $1838 in this example. The latest low was in a support area at $1858, which is $20 lower. We can see that the next resistance zone is $40 above 1878, serving as our target.
We have an account balance of $10,000, and we use the leverage of 50:1, which would allow a trade of 5 regular lots or a position size of $500,000. However, we want to employ strong risk management, so we only want to risk 2% of our trading account for this trade – 2% of $10,000 equals $200.
With a stop loss of $20, that would mean that we could trade a position of $5,000 – $5 x $20 stop = $100. We place a limit order to hit our target of $1878. $40 x $5 = $200 or a risk/reward ratio of $100/$200 or 1:2.
Crypto trading involves a high level of risk, but it doesn’t necessarily have to be ‘risky’ as long as you use a solid cryptocurrency risk management method.
Make protecting your account balance a priority over profit, and you will see your account balance steadily increase, even with a series of losses.
How to Calculate the Risk vs. Reward Ratio
Risk, in this context, is simply the difference between your entry price and your stop-loss price. So if your buy-in was $20 and your stop-loss is $19, you have a total of $1 at risk.
Your reward is the difference between your entry price and your target price.
Again, if the buy-in was $20 and the goal was $25, your potential reward would be $5. In this case, we have a 5:1 for the risk multiples.
You don’t just set your goal using multiple times your risk, as this will put an unrealistic target price. It’s a way of doing things backward. The correct way to define your goal is to use the previous areas of support and resistance.
If there is no support or resistance on the chart, the next logical choice is to use more significant whole numbers. These areas are good target attachment areas because they act as points of natural resistance.
Many people use their stop loss and their targets in the same areas, and therefore, those areas are solid.
If you had more than one goal, the best method is to average it. If Goal A was $6 and Goal B was $3, Goal C was $1, you can add them up and divide by 3, which will give you a goal of $3.
As long as your risk is one or less, you have the necessary 3:1 ratio that you need.
What else should you consider when calculating your risk vs. reward? Below are few things to put in place
Know your numbers
What is the actual average winner versus the real average loser?
If you add up your winning results and divide it by the number of winning trades you have, that will tell you how much you are earning on average.
It is effortless. If you win $500, $600, $1,000, and $1500, add the total and divide by the number of winners, and you will know how much you win on average.
The same goes for average losers. Add up the totals of how much you are losing on all of your trades and divide by the number of losing transactions you have, and you will know exactly how much you are losing on average.
These numbers are significant because now you should know how they compare to your expected reward for the risk. Revising this, if you only earn $1.5 instead of the $3 you expected, you are mistaken in thinking that you have a good reward/risk ratio.
Another example that we see here, if you have $4.25 and a risk of $2.35, you now have a reward/risk ratio of 3.15, and then you have to ask yourself if this fits into your trading plan.
Balance a High RR Multiple with a High Percentage Gain
Here, can you maintain a high reward for multiple risks and a high percentage of profit?
It is a balance between the two. I would recommend three or more for a bonus numerous and a 40% success rate. If you can maintain these numbers, you will be very successful.
While this can work occasionally, it is not an ideal way to trade. It is usually best to trade trades with lower risk vs. reward ratios, as this means that the profit potential outweighs the risk.
However, the risk/reward does not have to be very low to be effective; anything less than 1.0 is likely to produce better results than trading with a risk/reward ratio greater than 1.0.
The Risk vs. Reward Ratio Explained.
A risk/reward ratio compares the potential for the reward with the potential for loss. You calculate the risk by counting the ‘units’ between the predicted entry price and the predicted price at which you want to exit the market in the event of a losing trade.
You calculate the reward by the ‘units’ between the predicted entry price and the predicted price at which you want to exit the market in the event of a winning trade.
The reward is the expected amount of profit you want to generate on a winning deal.
To correctly manage risk, you should look for high probability trades with a risk/reward ratio of 1:2 or more. It depends on how long you want to trade.
For example, if you are a scalp trader looking to make only $30 on a trade, a stop loss of $15 is sufficient for a risk/reward ratio of 1: 2.
However, if you are a swing trader or a position trader with a more extended period, your profit potential will be higher. If you choose $200 as your expected profit, you will need to set your stop loss at $100.
You need to set a higher-stop loss because small trends occur in the more significant movement over a more extended period.
Withdrawals over a shorter period remain much lower compared to a more extended time. You will recycle your business. So that you don’t stop, you need to calculate your risk/reward ratio appropriately.
The second most important thing for traders is to minimize losses, in addition to maximizing profits. A crypto trader that only wins on average 50% of the time can be profitable.
Most traders want to earn money. But they don’t know how to protect what they currently have.
You have a 50/50 chance that the crypto market will go in your favor. It’s like flipping a coin. If the trade is not going in your favor and the market is going against you, you should cut your losses using the stop loss. Simply put, you cut your losses and let your winners run.
This simple 50/50 trading strategy generates profits even when a novice trader may suffer a loss.
Consider different risk-reward ratios. How much do you need to earn to cover the expenses of each proportion? For a 2:1 risk/reward ratio, you need 67% winners to be profitable.
For a 1:1 risk/reward ratio, that means only 50% of winners become profitable. The 1:2 ratio means that only 33.5% gain in profitability. Never trade when the risk vs. reward ratio is more significant than 1:2.
Risk vs. Reward Analysis
On its own, it seems that low-risk ratios of 0.1 or 0.2 are better, but that is not necessarily the case. It would be best to consider the odds of reaching your profit target before your stop loss.
You can make any trade attractive by setting your profit target far from the entry point, but how often will the market hit that high target before hitting the much closer stop loss level?
So there is a balance between taking trades that offer more profit than the risk but where the transaction still has a reasonable chance of hitting the target before the stop loss.
For most scalp traders, risk/reward ratios are generally between 1.0 and 0.25, although there are exceptions.
Scalp traders, swing traders, and investors should avoid trades with less profit potential than the stake, for example, a risk/reward ratio greater than 1.0. There are enough favorable opportunities that there is little reason to take more risk for less profit.
When setting the risk vs. reward for a trade, place the stop loss logically on the chart based on your strategy, and then place a logical profit target based on your strategy analysis. It would be best if you did not choose these levels at random.
First, you set the stop loss and profit target locations; only then do you assess the risk/reward of the trade and decide if the position is worth taking.
A common misconception is that traders have a particular risk/reward ratio in mind.
For example, they may only want to risk $0.05 to win $0.20, and so they enter the trade anywhere and place a stop loss at $0.05 and a profit target at $ 0.20.
Benefits of the Risk vs. Reward Ratio
As you can see, the risk/reward ratio benefits are numerous, so let me give you 6 of the top advantages you will get from it.
- Effective Stop Loss
The most significant advantage of using the risk/reward ratio in your trade is that it helps you activate stop-loss orders. With this, you don’t have to monitor the performance of your transactions regularly.
Stop-loss is especially handy when you are on tour or in a situation where you have not been able to control your position for a long time.
2. Preserves your Capital
If this is an apparent bull season, you can be more relaxed about risk/reward ratio and position sizes, and if you are confident, you can adopt a somewhat aggressive style of trading.
If the overall trend is bearish, then you shouldn’t be looking for trade opportunities. It would help if you let them appear.
3. Control Small Losses
It helps you control your small losses so that they won’t turn into big destructive ones. Also, it protects you against excessive loss.
4. Prevents Zero Balance
Risk vs. reward saves you from a ‘negative balance’; this prevents your account from going negative even if the market moves fast against your trades.
5. Emotional Stability
This strategy provides emotional support to you when market situations turn negative.
Controlling emotions involves identifying whether the principals in your predefined plan are practicing good risk management or are on the edge of the game.
The risk vs. reward ratio makes you feel more confident when executing a predefined plan that doesn’t consider the real-time excitement you might feel in the market.
Poor emotional control will often lead to FOMO (fear of missing out), chasing losses, buying without developing a basic understanding of coin fundamentals, stupid position sizes (all-inclusive)
Recognition of responsibility and accountability: Once you identify the potential risks, you can always rest assured. A solid risk to reward strategy will ensure that once assigned.
You can track your risk to ensure that it is dealt with quickly and efficiently.
Gunbot Risk vs. Reward
How to apply the risk vs. reward logic to Gunbot?
First, let’s be clear, you need to do your math and set the risk/reward ratio according to your preferences and what’s explained in this article. Remember, as long as your risk is lower than your reward. You should be fine, even if you have a few consecutive losses.
Once you get your number and after verifying your chosen pair on the chart, head over the “Miscellaneous” tab of your strategy settings on the GUI.
Here’s a Gunbot GUI Miscellaneous tab example:
Notice the numbers on the example are the “default” values. You need to add the number at which you want the bot to execute your Stop-Loss strategy.
Stop Limit: 9999, this is the default value, and that high number means your Stop Loss is disabled. The number you’ll add here will represent a percentage amount you want to sell if the price went down below your breakeven target.
For example, if you set your Stop Limit at 2, this number will signal Gunbot to sell your quote coin when the price drops 2% below your average bought price.
You can also set “SL Disable Buy” to true, which will tell the bot to “Do Not Buy when it Reach Stop Loss.”
Count Sell and Panic Sell are two other miscellaneous Gunbot parameters you can use if you want to limit your sell orders in the case of “Count Sell” and the panic sell, of course, if you’re going to sell fast at market price (beware of this setting because you may trade at a loss)
Risk vs. Reward Conclusion
This article discussed the concept of the Risk vs. Reward ratio and how to calculate it.
This trading plan is effective because it teaches you exactly when and where to enter a trade and where to place your stop loss levels and targets in various market conditions.
Then have a rule that says you only trade that produces a risk/reward ratio of a particular number or less.
You can use the risk vs. reward ratio combined with other risk management techniques, such as the profit/loss ratio. The profit loss ratio compares the number of winning and losing trades and your balance percentage.
Which gives the number of winning transactions that you need to execute to reach the breakeven point… But that’s content for a future article 🙂 Keep coming back for more!
Remember: Your trading strategy is only as good as your risk management.
The crypto trading game is all about probabilities, and there’s no way you can win all the time, which is why some losses are inevitable. The faster you understand and embrace this reality, the sooner you will start profiting.
Think of it this way: The earlier you cut your losses will determine how small your losses will be.
It’s crucial to cut losses before they become unmanageable and stop them before they become significant problems.
To manage risk, we must never invest more than we can afford to lose in any single trade. Most successful traders who risk less than 1% or 2% of their trading budget can keep themselves in the game.
Setting your risk limit and then sticking to it is a step in the right direction for managing risk. Doing so ensures you won’t risk more than you have and gives you a safety net for trades that don’t go as planned.
The bottom line is that investment management is vital to stay on top of your game, set time aside to keep learning and understand that you need to be patient before starting seen results.
Finally, accept that taking some losses is the cost of doing business.
Gunbot Helps You Profit
Gunbot helps you maximize your profits and minimize your risk by using advanced trading strategies on which you can define your risk/reward desired ratio, cut your losses or average down your total cost.
Gunbot is a crypto trading system, and what a trading system does is increase the probability of your trade working out and making you money against a randomly placed trade.
A cryptocurrency trading system is not a license to print money but simply a way to help you identify patterns or situations which have a higher percentage chance of making you money than a random guess.
Users love Gunbot because it is not meant to be a platform only for extremely experienced traders to do complex things. On the contrary, our easy-to-use crypto trading bot is built to service 98% of crypto investors who don’t have the skill or the time but desire to trade more actively.
And if you’re a part of the 2% that loves day-trading, and you’re already a successful manual trader, Gunbot it’s the perfect complement to your existing strategy.
Gunbot is the Automated Trading Software that all crypto traders are looking for! And now you know why. What are you waiting for? Seize Gunbot Now.