Asymmetric Risk Reward: The Secret to Success in Trading?Be as bold as you want yet protect your capital with the asymmetric risk reward strategy — an approach adopted by some of the greatest market wizards out there. In this Idea, we distill the concept of asymmetric bets and teach you how to risk little and earn big. Spoiler: legendary traders George Soros, Ray Dalio and Paul Tudor Jones love this trick.
Every trade you open has only two possible outcomes: you either turn a profit or make a loss. Perhaps the greatest thing you can learn about these two outcomes is the balance between them. The fundamental difference between making money and losing money — the mighty risk-reward ratio .
The risk-reward ratio is your trade’s upside relative to the downside you baked in (or realized).
Let’s Break It Down 🤸♂️
Most traders believe that you have to take huge risks to be successful. But that’s not what the big guys in the industry do with the piles of cash they’ve got. Instead, they try to take the least amount of risk possible with the most upside. That’s what asymmetric risk-reward ratio means.
Think of it this way: you invest $1 only if you believe you can ultimately make $5. Now your risk-reward ratio is set at 1:5, or a hit ratio of 20%. Safe to say that you’ll likely be wrong lots of times. But step by step, you can risk another dollar for that $5 reward and build up a good track record or more wins than losses. That way you can be wrong four times out of five and still make money.
Let’s scale it up and pull these two further apart. Let’s say you want to chase a juicier profit with a small risk. You can pursue a risk-reward ratio of 1 to 15, meaning you risk $1 to make $15. The odds are very much in your favor — you can be wrong 14 times out of 15 and still break even.
What Does This Look Like in Practice? 🧐
Suddenly, the EUR/USD is looking attractive and you’re convinced that it’s about to skyrocket after some big news shakes it up. You’re ready to ramp up your long position. Now comes decision time — what’s a safe level of risk relative to a handsome reward?
You decide to use leverage of 1:100 and buy one lot (100,000 units) at the price of $1.10. That means your investment is worth €1,000 but in practice you are selling $100,000 (because of the leverage) to buy the equivalent in euro. In a trade of that size one pip, or the fourth figure after the decimal (0.0001), carries a value of €10 in either direction.
If the exchange rate moves from $1.1000 to $1.1100, that’s 100 pips of profit worth a total of €1,000. But if the trade turns against you, you stand to lose the same amount per pip. Now, let’s go to the practical side of things.
You choose to widen the gap between risk and reward and aim for profit that’s 15 times your potential loss. You set your stop loss at a level that, if taken out, won’t sink your account to the point of no return. Let’s say you run a €10,000 account and you’ve already jammed €1,000 into the trade.
A safe place to set your stop loss would be a potential drawdown of 2%, or €200. In pip terms, that’s equal to 20 pips. To get to that 1:15 ratio, your desired profit level should be 300 pips, aiming for a reward of €3,000.
If materialized, the €3,000 profit will bump your account by 30% (that’s your return on equity), while your return on investment will surge 200%. And if you take the loss, you’d lose 2% of your total balance.
It’s How the Big Guys in the Industry Do It
You’d be surprised to know that most of the Wall Street legends have made their fortunes riding asymmetric bets. Short-term currency speculator George Soros explains how he broke the Bank of England with a one-way bet that risked no more than 4% of his fund’s capital to make over $1 billion in profits.
Ray Dalio talks about it when he says that one of the most important things in investing is to balance your aggressiveness and defensiveness. “In trading you have to be defensive and aggressive at the same time. If you are not aggressive, you are not going to make money, and if you are not defensive, you are not going to keep money.”
Paul Tudor Jones, another highly successful trader, spotlights the skewed risk-reward ratio as his path to big profits. “5:1 (risk /reward),” he says in an interview with motivational speaker Tony Robbins,” five to one means I’m risking one dollar to make five. What five to one does is allow you to have a hit ratio of 20%. I can actually be a complete imbecile. I can be wrong 80% of the time, and I’m still not going to lose.”
What’s Your Risk-Reward Ratio? 🤑
Are you using the risk-reward ratio to get the most out of your trades? Do you cut the losses and let your profits run by using stop losses and take profits? Share your experience below and let’s spin up a nice discussion!
Asymmetric
HOW TO use asymmetric compounding 🧐📈The pair in question and four winning trades allows me to cover a subject I've wanted to touch on.
That subject is asymmetric compounding.
Asymmetric compounding is a money management strategy that can accelerate the equity curve of an account.
But you need the right strategy and data available to back up using asymmetric compounding.
Higher the win rate the more asymmetric will work wonders on that equity curve.
In simple terms asymmetric compounding is best suited to strategies with higher win rates as you need consecutive wins to make it work.
The main reason for using this NZDUSD chart is the four winners in a row make it easier to explain the concept of asymmetric compounding.
You traders should know the full ins and outs of your own strategies and if this can be applied.
It's not just win rate also RR along with max losing and max winning runs need to be factored in.
For this example on the four winning trades I am explaining the concept basing it on risking 2% per trade on the initial trade.
As this strategy is a 1:2 risk reward strategy risking 2% sees us gain a profit of 4% on one winning trade.
This is where you can then use asymmetric compounding on your next trade.
Instead of risking 2% again you now risk the 4% gained from the previous trade on this trade.
If the trade goes on to win the 4% risked on that trade has just earned 8% in profit.
At this point you go back to risking 2% on the next trade until you have a win and then risk the 4% gain from that winning trade.
The chart shows four winning trades at 1:2 RR so lets test the concept in numbers.
If we was to risk 2% per trade on a £1000 starting capital account the results are as followed.
Trade one 2% risked 4% gained= £1040 capital.
Trade two 2% risked 4% gained= £1081.60 capital
Trade three 2% risked 4% gained= £1124.86 capital
Trade four 2% risked 4% gained= £1169.85 capital
Now if we apply asymmetric compounding to the same trade sequence staring back at original 2% risk after two winning trades
Trade one 2% risked 4% gained= £1040 capital.
Trade two 4% risked 8% gained= £1123.20 capital
Trade three 2% risked 4% gained= £1168.13 capital
Trade four 4% risked 8% gained= £1261.58 capital
Using asymmetric compounding on these four trades see a capital increase of £91.73 more than just risking a flat 2%.
Below is an example of using a 1:1 RR strategy risking 1% per trade. If trade is a winner then risk 2% on the next trade which is the profit and the risk from the previous trade. #
If that trade wins go back to the intial 1% risk then risk 2% again if that trade wins.
This is a great concept to grow small accounts or even pass funded challenges as with the trades shown on the idea chart you would pass most prop firm challenges in two trades using asymmetric compounding.
However I can't stress enough you as the trader need to know you own risk appetite for this.
You also need to factor in how good your win rates and how often your strategy has seen winning runs that would benefit this concept.
One way to found out is to back test and forward test your strategy to see how asymmetric compounding could work for you.
Thanks for taking time out your day to read over my idea.
Ill see you on the next one 👍
Darren
