Money Management
Risk-To-Reward Ratio
Your risk-to-reward (R:R) ratio determines how high your break-even win rate needs to be. Your R:R ratio can stay the same or change with each trade, depending on your personal strategy. There isn’t one R:R ratio that is universally better than another; it all depends on your individual trading style.
A 0.5:1 ratio would require a 66% win rate, 1:1 would need a 50% win rate, 2:1 needs 33%, and so on. Don’t forget to account for fees in your calculations.
Leverage
Leverage allows you to trade with more capital than you actually have. Like a 1:10 leverage gives you access to 10x the money you have.
This has many benefits, such as enabling you to open multiple positions, increasing profit potential, trading in low-volatility markets, and allowing for more precise risk management.
It’s a great tool when understood, but if not used carefully, it can be detrimental to your account balance. In some cases, you can even go into a negative balance on your trading account, meaning you lose all your invested money and may have to pay the broker the additional amount you lost. Some brokers offer negative balance protection, but not all do.
In short: Don’t use leverage until you fully understand it.
Compound Interest
Albert Einstein apparently called compound interest the 8th wonder of the world. It’s what has made many wealthy people rich, and it’s very simple to understand and use. Essentially, it’s earning interest on already acquired interest and repeating that process over and over again. That’s it, literally.
A 10% annual return would compound to a 1,105.69% gain over 25 years or 5,270.07% after 40 years. It can be your greatest asset, but like leverage, it can also be your worst enemy. Losses compound just like gains.
However, as long as you have a profitable strategy, compounding will greatly increase your returns over time.
Patience is crucial with compounding because while the potential is there, progress may seem slow in the beginning.
Stop Loss
You should never approach a trade thinking, “If I win, I’ll make X amount.” Instead, do the opposite: “If my trade reaches this level, it’s most likely that I was wrong, and I’ll lose X amount.” Know how much you’re risking and make that your priority—profits come afterward.
Don’t place your stop loss where you want it but where it needs to be. If that leads to risking too much, it’s not a trade you should take. Never risk more than your strategy allows, and never move your stop loss lower after entering a trade. Most professional traders risk between 0.5% and 2% per trade.
You can consider trailing stop losses, but they can result in more losing trades if used incorrectly.
Fees
Every broker has their fees listed somewhere. Include those in your calculations. A statistically profitable strategy can still fail because of fees. Another factor to consider is overnight fees and margin requirements, which can be detrimental to your strategy if not accounted for.
Conclusion
Find an R:R ratio that you’re comfortable with and stick to it. Read up on leverage and use it the way it’s meant to be used. Try to compound as often as you can, but be aware of the downsides. Always place your stop loss first and make it the foundation of your trade. Also, always risk the same percentage per trade, and last but not least, know. your. fees.
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