Risk/reward and position sizing is so important to trading that I believe that it deserves its own section. I will go over the essentials and basics but I encourage you to do research more on the topic and study the concept entirely before deciding to trade. This is an example of 3:1 risk/reward showing a 50% winning percentage can still generate profits. Small gains add up. Each trade is $10000
Please note, The calculation of risk/reward is very easy. You simply divide your net profit (the reward) by the price of your maximum risk. Some investors won't commit their money to any investment that isn't at least 4:1, but 2:1 is considered the minimum by most. Of course, you have to decide for yourself what the acceptable ratio is for you.
Having an edge when trading is so important that when people do not grasp this concept they can potentially blow their accounts. Position sizing will also determine your profit. Determining the proper position size before a trade can have a very positive impact on our trading results. Position size is adjusted to reflect the risk involved in the trade. Depending on the size of the trading account, traders should risk a maximum of 1-3% of our account on a trade. Most successful traders base their position sizing in my trades on the fact that they never want to lose more than 1% on any one trade. For example, if you are trading with a $100,000 account, you don’t want to lose more than $1,000 in a losing trade. A stop loss level has to start at the price level that you know you are wrong, and work back to position sizing.
More examples
A 20% position of your total trading capital gives you a potential 5% stop loss on your position to equal 1% of total trading capital.
A 10% position of your total trading capital gives you a potential 10% stop loss on your position to equal 1% of total trading capital.
A 5% position of your total trading capital gives you a potential 20% stop loss on your position to equal 1% of total trading capital.
A Quick video on the importance of "having edge" by Adam Khoo
- Trade like a casino not like a gambler