We mentioned in the series that a trading strategy with a 50% win rate and a reward to risk ratio of 1:1 will eventually lead to an account coming to zero, as the law of large numbers will catch up with the account, considering that you will always require more to restore the account to break even.
In reality, getting a trading strategy that would give a reward to risk ratio of 3:1 is likened to finding a needle in a haystack.
It is possible but may be challenging to find and not too many signals.
Strategies with reward to risk ratio of 2:1 and 1:1 are more common in the industry, however, to be successful, an approach with a reward-to-risk ratio of 2:1 must not have less than a 50% win rate, and the strategy of 1:1 reward-to-risk ratio must not have less than a 65% win rate.
The second strategy also boosts optimism in human traders as they often prefer to see green on their trading history.
A trader’s drawdown is often the decline of his/her capital following a series of consecutive losing trades, calculated by taking the difference of the relative peak and the corresponding trough.
Drawdowns come as a result of losing streaks and are a natural part of trading. Avoiding a drawdown in trading is likened to breathing in but not wanting to breathe out. It just doesn’t happen.
With a robust risk management rule in place, consistent success can be your experience.
Maximal Adverse Excursion
Maximal adverse excursion assesses each trade in a strategy and defines the drawdown at which trades will most likely not recover.
Similar to support and resistance levels in trading, once the MAE drawdown of a trade level is breached, such trades generally do not recover though the possibility of trades experiencing abnormal drawdowns while still going in the expected direction does exist. Such trades are rare and not worth the risk to hold on to them.
Fixed Fractional Money Management
Apart from managing your risk, another piece of the puzzle for successful trading is money management.
We recommend fixed fractional money management, which allows you to scale up your trade size without exposing your capital to unforeseen risks. Following a fractional money management strategy, your trades are managed by setting aside a portion of your trading equity.
Most trading brokers and exchanges usually have a cabinet on your profile where you can have your money deposited, which is different from your trading account.
To go about trading this way does not only limit your risk; it does allow you to increase your account size.
The higher your equity grows, the more funds you have available for trading, and the more capital your system can earn, which lends itself to be an account buffer that is protected.
Here is how the strategy works:
Let’s assume you are willing to risk 20% of your initial capital, say $100,000. This gives you $20,000 in trading capital to buy or sell any cryptocurrency of your choice.
Now let’s say you bought BTC during the crypto rush of 2017 when prices were hovering at $300 per BTC. This gives you a profit of about $75,000.
The profit gained also increase your total equity to $175,000 which consequently increases your trading capital to $35,000 (20% of $175,000), and allows you to secure the rest in your vault, which is separate from your trading capital.
Notice that your total equity grows in proportion to your investment pool. This is considering that you only expose a fixed percentage of your capital at intervals which allows you to scale up your positions.
Martingale and Anti-Martingale Money management
Knowing how to manage your risk capital, following a losing streak cannot be overemphasized. For this reason, traders deploy one of the two money management strategies after experiencing some loss.
The martingale system is one of the major killers of traders’ capital, as they attempt to dig their way out of a losing trade by increasing their risk in the next.
Traders that adopt this system would double their trade size, following a loss of the previous trade.
There’s this famous saying that you never try to catch a falling knife. Followers of the martingale technique do the opposite of this and end up getting their hands cut over and over again.
Cut your losses short and let your winners run!
The anti-martingale involves money management is the one we recommend here.
Suppose you experience a streak of losing trades on your account. The anti-martingale suggests that you reduce your trade size (risk) while you are in a drawdown, and increase your trade size as your capital comes out of drawdown. This is a safer way to trade as it allows your capital to stand the test of time and ware out the storm until the profits period shows up.
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