Reward/Risk Ratio
The risk/reward ratio is very important concept that determine the success of a trader. As a short term trader , we have been taught to set a target entry, exit price and stop loss if the trade goes against us after doing homework on the fundamental and technical indicators in the chart and it is beyond reasonable doubt that we are convinced of the entry. But have we wonder the other side of the trade if the reward justify the amount of risk we are willingly to undertake? of course, all of the traders in the world would love to have their reward to the most and the risk to be the least. The question next is then what is the reasonable reward/risk ratio? A good rule of thumb is to attain a return of three times as much as the amount risked, making the reward/risk ratio 3 to 1, or maybe anywhere between 2 to 1 and 4 to 1. To attain consistency and profitable trades in the long run ,your rewards must be bigger than your risks over time so that you can make money. I have spent much time studying the phenomenal gains of a trader. Let examine what the secrets behind a successful options trader. Firstly, he is a very discipline trader who always will not risk more than 5% of his trading capital in any position's. He will factor the odds of a 5 winning trade that make 200% profit and a worst case of 5 loosing trades of 100% after a tight stop loss, in other word, he has in fact only 50-50 chances of winning, but his 5 winner make him 1000% and his 5 loosing trade loss him 500% thereby still giving him a net gain of 500%. A good trader knows that he will not win in every games he plays but the beauty of options is the leverage they provide. It takes only a few winners out of every 10 trades to make him a very happy investor. In conclusion, it is not the setting of targets and stops based on a predetermined risk/reward ratio. Big targets and tight stops are pointless if the system is a net loser but rather a trading system which have a success rate of a few phenomenal winners over the losers.
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