Often we hear about the volatility of the crypto market. Yes, many crypto traders always want to buy assets at a very low price and sell them off at high prices to make a profit, but unfortunately, the volatility attached to the crypto market cannot be predicted, and profit cannot be guaranteed every time.
Although some traders are quite knowledgeable about these trades by constantly monitoring and studying price charts and historical data and using them as inferences in predicting the next big move, which is quite commendable but sadly, not every trader takes the time to study the profit or loss attached to any risk taken.
Whether you are a beginner or an experienced trader, this guide will equip you with everything you need to know and understand about the risk/reward ratio concept and how to calculate it in crypto trading. Keep Reading!
Key Takeaways
• Whether as a regular trader or an investor, the risk factor would always play against you, especially in a volatile market like the crypto market.
• A proper understanding of a good risk/reward ratio will assist in planning a proper risk management strategy.
• It will also help determine whether a trader will succeed and achieve their financial goals in the long run.
• Understanding the relationship between the stop loss and take profit will also help the trader to differentiate an ideal reward from potential risk.
SEE ALSO: How Not To Stop-Loss In Crypto Trading (A Beginner’s Guide)
SEE ALSO: 10 Tips For Day Trading Crypto in a Bearish Market
What is the Risk/Reward Ratio?
When we talk about the risk/reward ratio, it deals mainly with the potential losses or gains accrued from any trade. It can also be defined as a process used to access the difference of entry points, stop loss, and take profit orders based on the Risk/Reward ratio.
For crypto traders to identify risk and make a considerable gain, they must identify the gap between the opening point and the stop-loss order, i.e., using the distance between the entry point and the profit target as a yardstick for measuring the take-profit level.
How to Calculate Risk-Reward Ratio?
The formula for calculating the Risk-Reward Ratio is as follows:
Risk-Reward Ratio = (Possible Loss from the Investment) / (Possible Profit from the Investment)
For instance, let’s say;
You purchase BTC for $60,000,
You have a Stop Loss of $55,000,
You expect BTC to go up to $70,000.
Peradventure, the price of BTC falls, the stop loss will automatically come into full action, and you would immediately lose about $5,000 ( That is, subtract the selling price from the purchase price – $55,000 -$60,000). Thereby setting the possible loss from that trade at exactly $5000.
Whereas, if the price of BTC soars higher and reaches about $70,000, you would automatically gain $10,000 ( subtract the purchase price from the selling price). From this case study, the Risk-Reward Ratio is 1:2 ($5,000 / $10,000).
What is the Risk/Reward Ratio trying to tell us?
Finding and identifying trends in a volatile market like the cryptocurrency market, whether using technical analysis or fundamental analysis, can take a lot of work.
Regardless, the risk/reward ratio from time immemorial remains one of those tools that can be used in identifying a trade entry point to a stop-loss or take-profit order.
Due to an unpredictable market, the risk/reward ratio is essential for all traders as it will help them increase the odds of winning and making more profits.
It is recommended that you avoid trading all your investments in a single trade because it can be disastrous. Of what essence is risking your $2,000 for a $200 gain?
Like most crypto analysts would advise, always ensure a risk/reward ratio of no greater than 1:2, or 0.5, for recommended trades.
Frequently Asked Questions (FAQs)
What is the 1.5 risk to reward Ratio?
How do you use the risk-reward RR ratio for crypto trading?
Using the entry price, stop losses and take profit orders, you can use the risk/reward ratio to measure the possibility of profit or loss from each trade.
Final Thoughts
A common mistake among crypto day traders is analyzing the crypto market with a prior risk/reward ratio in mind, which can lead to a loss if they set their take profits levels and stop loss based on their entry point.
Therefore, in calculating their risk/reward ratio, they should consider the risk per trade, market conditions in play at that period, and the value of their total investment.
You can also use several significant factors in trading to set a reasonable take-profit level to maximize profit and minimize loss.
Suitable market conditions, finding the appropriate price levels to set the stop loss, and considering the break-even percentage will increase the probability of making profits asides from providing an excellent risk/reward ratio.
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