This week we’re going to take a look into risk management. Risk management allows us to have an edge in the markets even if we only win 30% of our trades. Imagine losing 70 trades out of 100 and still being in profit, it’s not actually as crazy as it sounds. We have touched on this a little in the past within a previous blog, but we’re going to look into this in more detail here.
First of all, we need to understand what risk management encompasses. The two key areas we are going to focus on today are the risk-to-reward at the trade outset and trade management once in a trade.
Risk-to-reward at trade outset
Different strike rates require a different average R to stay breakeven. Let’s take a look at the average R required for your strike rate:
If you have a strike rate of 50%, then your minimum average R to be breakeven is 1
If you have a strike rate of 40%, then your minimum average R to be breakeven is 1.5
If you have a strike rate of 30%, then your minimum average R to be breakeven is 2.33•
If you have a strike rate of 20%, then your minimum average R to be breakeven is 4
We can see from this that simply incorporating a minimum risk-to-reward of 1:3 with a strike rate of 30% would actually enable us to be profitable over time. Take a look at the example below of an account size of £50,000 risking 1%.
In this first example you can see that when we lose, we lose £500. But if we win, just like in the second example below, we win £1,500.
If we did this 10 times and only won 3 trades, therefore having a 30% strike rate we would have the following results:
Losses = 7 x £500 = -£3,500
Wins = 3 x £4,500 = +£4,500
Overall = +£1,000
If we could simply increase our strike rate to 50% this would result in +£5,000 after 10 trades.
I wouldn’t recommend simply targeting 3R as the market doesn’t care where you get in or get out, the market will move based on liquidity. The biggest tip, therefore, would be to choose your target, stop and entry based on your strategy and if the risk-to-reward isn’t relevant to your strike rate then I would have this as filter to not take the trade.
Finally, even after seeing how we can still make money whilst losing 70% of our trades, there is another way that we can improve on this edge, trade management. If we can keep the same strike rate and the same minimum risk-to-reward but we implement trade management so that when we do lose, we lose –0.7R on average instead of –1R we can have an even greater edge.
If we look at the above example again with a 30% strike rate but now every time we lose we only lose an average of -£350 instead, after 10 trades we would be up +£2,050
We can more than double our edge with simple trade management whilst keeping the same strike rate and minimum average R.
If you want to learn how we manage our trades check out the Advanced Trader Video Course where details such as this and much more are covered!
Until next week, safe trading.