Risk Reward is probably the most important aspect in regard to trading or investing.
Understanding the risk in contrast to the possible reward is a fundamental factor in determining if a trade or investment is worthwhile. If you are able to calculate the risk/reward ratio for your strategy then you are able to also calculate your maximum monetary risk against your account and position size accordingly.
Your win to loss ratio and potential losing run sequence also become a factor, combining all these aspects allows you to trade your strategy with the knowledge that your account will endure any losing run and allow for your trading edge to materialise.
Our Risk Reward Simulator is a hugely important tool if you are looking to take trading seriously. You can change any metric on the spreadsheet for any permutation to determine the viability of a strategy.
The example shown below shows a 16 to 1 Risk Reward ratio i.e risking 100 to win 1600. Notice how a win strike rate of just 20% can yield excellent profits.
A win rate of just 20% means you can allow for 8 losing trades out of the 10 placed. In this example we make 100 trades and run the simulation 10 times to determine the possible outcomes.
The equity curves show the extremes of all the permutations.
We see a maximum return of almost $35,000 with very little drawdown along the way, and a minimum return of $11,000.
Notice that the worst-case scenario is a 27 losing streak, this is an important metric because you can determine your possible drawdown based on the amount risked. Let’s say you risked 2% of your account on each trade, this would have equated to a drawdown of 54%. You could therefore perhaps conclude that a 1% risk per trade is more suitable to allow for your trading edge to materialise.
It is our belief that before a trading strategy is implemented you must understand the metrics and therefore the viability before putting any money into the markets.
You can purchase the simulator here for just £4.99. Our site is free and this contribution will help support the website and would be much appreciated.
You will often see the simulator in our videos due to the importance we put on the risk reward aspects of trading.
Good luck!