How to Determine the Perfect Risk per Trade.Bitcoin / U.S. dollarBITSTAMP:BTCUSDTopChartPatternsHow to Determine the Perfect Risk per Trade. When I started in trading years ago I had an idea with some friends. My friend, who had read a couple of books, proposed an idea worthy of the best Quants. We create an account, put 10,000 dollars between us, and look for 4 favorable market entries. We had read some books, so what could go wrong? We knew what a moving average was, a MACD, and little else. But the idea was great, look at this beautiful plan! Initial Balance -> 10,000 Trade 1 -> 18,000 Trade 2 -> 32,400 Trade 3 -> 58,320 Trade 4 -> 104,976 If we risk 80% of the capital on each trade, in ONLY 4 successful operations we would be above $100,000 , a x10 in 4 trades. At that point we were going to stop and get out. Our plan: Buying when a Moving Average crosses, nothing could go wrong! Against all odds, the first trade worked. The second one too! But the third one was painful. When we were looking to go above $50k the account went directly to a margin call. After trying to understand what we had done wrong, there are two things we clearly did not understand yet. 1. What was our win rate? 2. What was the probability of this idea working out? Assuming we were novices and entered in a fairly random way, let us assume an average win rate of 50%. Since the TP and SL were at the same distance, it is a reasonable thing to think. **Acc. Balance | % of Success** Initial Balance -> 10,000 Trade 1 -> 18,000 | 50.0% Trade 2 -> 32,400 | 25.0% Trade 3 -> 58,320 | 12.5% Trade 4 -> 104,976 | 6.3% Our real chances of achieving the goal, of hitting these 4 trades, were only 6%. Or for the beginners, we were going to hit a margin call with 94% probability. The good part is that the margin call left about 7,000 dollars in the account, so not too bad. We lost $3,000 but we learned something that today you get for free. What is the best percentage to risk for a strategy? You are going to read a lot of nonsense, but nobody tells you numbers. Some say 1%, perfect, and why? Why not 0.5% or 2%? Today I give you the definitive figures so you understand the basics, according to your strategy, of what you should risk on each trade. The objectives will be: NEVER have a risk of ruin, meaning a Margin Call is not triggered. Maximize Profit after several operations. For this you will need to know the Win rate of your strategy, meaning how many times you win and how many you lose. We will assume several win rates close to 50%. And on the other hand, we will have the variable of the % risked in each trade. To keep it simple, the TP and SL will be at the same distance and there will be no bid/ask or commissions. We assume the entry is free. If the TP and SL are at different distances, then the math becomes somewhat more complex, and it does not add much to understanding the concept. Systems with 50% win rate If half the time I win 2% and the other half I lose 2%, what probability do we have of winning and losing? If you think it is 50/50 to win or lose, you are wrong. The reality is somewhat harder. After enough sessions, a system like this ALWAYS goes broke. By losing 2% of 10,000 dollars, we will drop to 9,800 dollars. By winning 2% in the next trade, we will go up to 9,996 dollars, so after one win and one loss we are already 4 dollars below. If we run many simulations, these are the figures after 100 trades, 1000 trades, and 2500 trades. Notice that 28% of the accounts end in a Margin Call (Ruin risk). As for the rest, it is true that some do quite well and end up compensating for the bad ones, but it cannot be that one in four times our system goes broke. If we move the Win rate to 51%, our risk of ruin is reduced to 4% with an improvement of only 1% in successes! Notice how relevant it is to control your WIN RATE. In addition to having a risk of ruin of 4%, now the system manages to gain 50% after 1,000 trades, but honestly, it is not very sexy. To have more profits, why not increase the risk per trade? Good idea, let us risk 3%! Still far from my 80%. 🫣 With this, you just raised the risk of ruin to 1 out of 4 accounts. It is very likely that your account will break, but at the same time, on average (taking into account the broken accounts too) the profit is double than before, almost 100% with 1,000 trades. If we go to 8%, the picture becomes devastating. We go broke in 96% of our tested accounts and the returns are weak. This is NOT the way, as risking more reaches a moment where it does not pay off. Let us analyze the other path. We are going to focus on improving our Win rate, achieve a better entry, and go for it. We will keep the risk at 3% as before, but imagine we manage to raise the win rate from the previous 51% to 55%. By improving the win rate by only 4 points, our probability of ruin disappears completely and the returns scale in an incredible way. If we raise our risk to 5%, the risk of ruin reappears although in a very subtle way. Improving the win rate is undoubtedly key to avoiding the risk of ruin, much more than the risk per operation is. How do I determine an optimal risk for a system? When I have a system sufficiently tested, I look for its win rate over time. In moments more favorable to the system the win rate goes up and in others it goes down. I do a trailing win rate of about 100 periods. If the system is good, this win rate is very, very stable because it knows how to navigate any situation. Even so, from the win rate that comes out, let us suppose 65%, we subtract 10% as a margin of safety and leave it at 55%. In this 55%, we look for the % risk that does not generate probability of ruin, in this case 4%. Now, we have a system that wins 65% of the time, but even by stressing it and making it drop to 55% we still have no risk of ruin. No matter how many trades we do, if we do it right, the system is unbreakable. In the coming days I will publish how systems with a win rate of 70% or more are sought and how having several systems working at the same time makes the risk of a drawdown even lower, reducing volatility and improving profits. 👇 WANT MORE? 🚀 Hit the rocket, read my profile and follow so we can find each other again.