RISK-REWARD RATIO

RISK-REWARD RATIO

80% of the day traders in India are not familiar with the concept of risk and reward. They just invest their hard earned money into the market without any calculated risks and targets. The first priority of a day trader should be to manage his risk and reward ratio.  Now what do you mean by risk and reward. Risk is basically your ability to trail the stop loss. Let’s understand this through an example, if you feel that the market is bearish and suppose the current price of your stock is Rs. 100.

You short 10 shares therefore your total sale value is 10×100=1000. Now if you think that your maximum loss should be Rs. 100 than you place your stop loss at Rs. 101 and according to your analysis you feel that the stock will up to Rs. 95, then you fix your target at Rs. 95 which will give you the profit of Rs. 500. Now for the profit of Rs. 500 you are willing to sacrifice Rs. 100 if the stock moves upwards. This means that your risk to reward ratio is 1:5(100:500), which is a good risk to reward ratio. The higher the ratio the better it is. But the key to not losing your capital is to stick to your stop loss. People often trail their stop loss in a hope that the stock is taking a pull back before actually moving into their direction but in this situation if the market moves opposite of your expected direction than can you lose all your capital. So the bottom line is that you should never first plan your profits but your losses should be pre-determined and absolute.

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