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Risk to reward ratio

Risk to reward ratio

The risk-to-reward (R/R) ratio is one of the most powerful trading metrics. In crypto trading, it helps traders to minimize risk and maximize profit Using the R/R ratio, you can increase your profitability by setting strategic losses and taking profit orders.

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What is the risk/reward ratio?

The risk/reward ratio is used to measure the potential upside and downside of any trade using entry price, stop loss and take profit orders. So, there are two main tools you need to implement the risk/reward ratio: stop loss and take profit orders.

At Phemex, you can set a stop loss to exit the trade if your position changes. For example, if you enter a buy BTC position at $40,000 and your stop loss is set at 5%, it will automatically close at $38,000.

Traders at Phemex can also set up automatic profit taking orders. If your profit target is 15% and your entry price is $40,000, the take profit will automatically close your trade at $46,000.

What is a good risk/reward ratio?

The risk/reward ratio can be calculated using formulas, but the idea is that you enter a trade where the potential for profit is higher than the potential for loss. A risk/reward ratio of 1:3 – in other words, you only risk $1 but earn up to $3 – is considered optimal among many cryptocurrency investors and is often used in calculation formulas as “0.3” is read

The risk/reward ratio can be lower or higher than 0.3, but higher risk minimizes your chances of profit, while lower risk does not always bring you good profit. It is recommended to have a maximum risk/reward ratio of 0.5. With this ratio, you have a higher chance of making a profit.

Why is risk/reward important?

The risk-reward ratio is the simplest and most powerful trading metric because it mathematically calculates the upside and downside of each trade, allowing you to make a calculated trade. It is arguably more important than “win rate” because it can be applied to all trades, regardless of your trading history.

If you have an 80% win rate (8 out of 10 trades are successful), you can still lose your entire balance on one bad trade. If you use R/R calculations, you can minimize your trading risk and set a stop loss that allows you to recover your initial loss. This makes it possible to run a profitable system even with a lower win rate.

Trades don’t always have to take a break and take, but a risk/reward calculation lets you know what you’re getting into. For example, when your withdrawal margin is set at $45,000 on a Bitcoin trade, the R/R may be 1:3, but you can remove the withdrawal margin and let it run to $50,000 and the margin create more profit for you.

Professional traders like to calculate the risk/reward ratio of each trade because they risk a lot of capital. If you enter a trade of more than $1,000,000, you want to know that there is a stop loss that prevents you from losing a lot of capital if the trade goes wrong. Likewise, people trading with only $1,000 will benefit from similar tools

As we will explain below, the relationship between these instruments is very important for calculating the R/R ratio of any trade.

How to calculate the risk/reward ratio for crypto trading

To calculate the risk/reward ratio of your crypto trade, you need to have a base “entry price”. The entry price is the price of the crypto at the moment you enter the trade. For example, it might be $48,000 for BTC or $3,500 for ETH. Calculations are made from a base entry.
The “risk” in the R/R rating means the maximum loss you can take on that trade. This is indicated by the stop loss setting. “Reward” is the automatic profit that you will get after a trade reaches a certain price.

R/R Ration formula

The R/R ratio is calculated by dividing the risk by the reward. We can do the calculations for each trade using a simple formula:
(Entry Price – Stop Loss) / (Take Profit – Entry Price) = Risk Reward Ratio
Here’s how to apply this formula to Bitcoin trading:

  • Entry price: $50,000
  • Stop loss: $48,000
  • Profit received: $54,000

Calculation: (50000 – 48000) / (54000 – 50000) = 2000 / 4000 = 0.5

This deal has an R/R ratio of 0.5. To keep your trades consistently profitable, you want to aim for an R/R ratio of 0.3-0.5.

The same calculation can be applied to an ETH transaction:

  • Entry price: $2,800
  • Stop loss: $2,600
  • Profit received: 3400 dollars

Calculation: (2800-2600) / (3400-2800) = 200 / 600 = 0.3

Here is another ETH trade where the R/R ratio is 1 (equal risk/reward):

  • Entry price: $2,800
  • Stop loss: $2,600
  • Profit received: 3000 dollars

Calculation: (2800-2600) / (3000-2800) = 200 / 200 = 1

The second ETH trade is less risky than the first ETH trade because the withdrawal profit is set at $3,000, which is more likely to be reached before ETH reaches $3,400. However, the upside potential is also minimal.

There are only three possible outcomes: risk is greater than reward, reward is greater than risk, or risk equals reward. If the R/R ratio exceeds 1, you will be rewarded less than the amount you risk losing.

In calculating the risk/reward ratio, stop loss and gain profit

Using trading strategies like R/R only makes sense when you use trading tools like stop loss and take profit orders.

Calculating R/R can also help you calculate the return you need to make up for a capital loss. This becomes exponentially more difficult the more capital you lose.

Does the risk/reward ratio work for reward?

The R/R ratio is used for stock trading and crypto trading alike. However, R/R ratios are much more reliable for stock markets because stock markets are less prone to volatile fluctuations. Crypto markets are in the early stages of development and are much more volatile.

The market capitalization of digital currencies is smaller than that of forex or gold, making it susceptible to extreme price fluctuations caused by small forces such as whales holding large reserves of digital currencies. The so-called “bitcoin whales” are having a ripple effect on the markets, especially miners who are selling their coins to stay profitable. Additionally, altcoins are often influenced by Bitcoin’s behavior.

In crypto markets, it is common for major cryptos to fluctuate 10-20% in a day. Crypto traders need to watch out for news in the crypto world that can cause the price of crypto to rise or fall rapidly. If you’re trading ETH or other alts, you need to keep up with the BTC price.

The main point is that you cannot rely on the R/R model alone and must follow other developments in the crypto markets. Imagine you have calculated a relatively low-risk BTC trade with an R/R rating of 0.3.

Advantages and disadvantages of risk-reward ratio

1. Risk-to-reward ratio profit 

The advantage of the risk-reward ratio is that it allows the investor or trader to manage the risk of their trade. A person can protect himself from taking too much risk for too little reward. However, it also has a limitation.

2. Limiting the ratio of risk to reward

Risk-reward ratio cannot be used in isolation. It should be used with other tools and techniques to make successful investment decisions.
Several other factors must also be considered, such as:

  • Current market conditions
  • Trade timing
  • stop loss
  •  Target profit levels
  • Technical analysis
  • and many others

last word

The risk/reward ratio (R/R) calculates the limits of return you can expect per unit of risk. An ideal trade has a higher potential reward than risk. If you have an R/R ratio of 0.3, that means you will make $3 for every $1 you risk. For most trades, a risk ratio of up to 0.5 is recommended.

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