Have you ever wondered what separates the winners from the losers in the stock market? The answer may not be entirely intelligence but an age old concept called risk to reward.
The stock market is full of people who are extremely intelligent. After all, it is one of the toughest arena in the world.
But even so, the most intelligent person in the world cannot control the stock market. If the market wants to crash, there is no amount of buying that can keep the market up.
Temporarily yes, but long term no.
Every day the market goes up and down.
Sometimes it can roar up furiously in a week. The next week it can go down.
If the market is crashing, you will not be able to make money buying stocks.
Since you can't stop the market from dropping, you can stop yourself from buying stocks.
Plain simple right.
Try to have a system that is able to tell you when you should be in the market and when you should not be in the market. A simple trend following strategy will be able to keep you on the right side of the market.
Have you ever been in a situation where you have the perfect setup and then enter the stock?
You make money in the first day but by tomorrow the stock tanks and your stop loss is triggered.
Happens to me and many other traders all the time.
If you had not experienced that, you have not been trading LOL.
So if you can't control what the stock does what can you do?
Well, there is this concept call risk to reward. Or some call it reward to risk.
What this means is you should find a trading strategy that gives you limited risk but maximum reward.
A good reward to risk scenario would be if you lose you only lose $100. But when you win you can win $200.
That is a reward to risk ratio of 2:1
I think one of the best gifts you can give yourself is to accept that you will lose in the stock market quite often.
A good win rate would be 60% of the time.
That means out of 10 trades you win 6 trades. And out of 10 trades you lose 4 times.
That is the reality of trading. If someone tells you that you can win 100% of the time run fast away from that person. That is not the reality of trading.
So my friends...what if you combine the 60% win rate with a reward to risk ratio of 2:1
This is the picture of a person risking $100 per trade:
Okay the above is quite simplistic. There will be times when you will lose more because of gap downs. But I think you get the idea.
Overall you will still win despite losing 40% of the time. The reward to risk also helps you a lot.
Out of 10 trades you lose $400 but your wins are $1200. So by the end of the day or week or month, you make $800.
What if we increase your losing rate to 50%?
Well out of 10 trades you will lose $500 and you only win $1000 and minus the losses your overall profit is $500.
How could you make money when you only win 50% of the time?
It doesn't make sense right?
But its the Reward To Risk that makes the difference.
Think about it and let me know what you think : )
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