Experienced investors and traders take cryptocurrency trading seriously. They are used to carefully weighing their chances in search of the highest entry and exit points. If one position makes the same profit as another but a less risky, it will prove to be a much better investment.
So, how to calculate the Risk/Reward ratio when trading crypto? Let’s review this question together!
What is a Risk/Reward Ratio (RR) ❓
The Risk/Reward Ratio (RR) shows the ratio of the possible risk to the possible profit. The exact value of this ratio is calculated before you buy an asset to understand the transaction’s potential in terms of trading strategy.
For example, if RR>1, the risk exceeds the possible profit. When the ratio value is less than 1, the potential returns are higher than the risk.
How to Calculate the Ratio ❓
Usually, traders divide risk by profit or vice versa. However, the most common way to calculate it is as follows:
RR = (Target Price – Stop Loss) / (Target Price – Entry Price)
For example, the entry price is $150, and then you put a stop loss at $140 and an exit price at $180. In that case, the ratio is 1 to 3 or 0.33 (the risks are less than the potential gain).
What Is the Optimal Risk/Reward Ratio ❓
One of the most common values is 1 to 3, or a ratio of 0.33. Ratios 1 to 7, 1 to 10, and 1 to 15 also apply.
However, it would be best if you did not exclusively rely on the commonly accepted Risk/Reward Ratio (RR) values because none of them is 100% suitable for every trading strategy. It is necessary to look at the results of transaction testing, statistics, and the current market situation.
For example, if a trader has only 50% of successful transactions, then his RR=0.5 or 1 to 2. But such a ratio will not be helpful because the target selling price of a coin or token should bring profit in general, not in a specific position.
The most common ratio of 1 to 3 means that one profitable transaction should cover three unprofitable ones.
Why Calculate RR ❓
Traders calculate the Risk/Reward ratio to effectively use the chosen trading strategy by adjusting the desired level of risk and profit. It allows for a more or less stable income in the long term.
Even if traders have 30% of successful operations on their account, a good ratio of potential risk and profit can benefit them greatly.
Before calculating the Risk/Reward ratio, the trader assesses the potential for price movement, finds the entry point into the position, forecasts the price movement of the coin or token, and determines the exit point.
After that, you can calculate the ratio of the potential risk to profit and compare it to the chosen trading strategy.