Understanding Risk Asymmetry in a Table▮ Introduction
With TradingView's new table creation feature , you can easily create and customize tables to enhance your trading analysis and presentations.
In this article I'll use it to explain Risk Asymmetry .
Trading involves a constant evaluation of risk and reward .
One of the critical concepts that traders need to understand is risk asymmetry .
This concept highlights how losses and gains are not symmetrical.
In other words, the percentage gain required to recover from a loss is greater than the percentage loss itself.
This article explores risk asymmetry and illustrates it with a practical example.
▮ What is Risk Asymmetry?
Risk asymmetry refers to the disproportionate relationship between losses and the gains required to recover from those losses.
For instance, if you lose 10% of your investment, you need to gain more than 10% to get back to your original amount.
This is because the base amount has decreased after the loss.
Understanding risk asymmetry is crucial for traders because it affects their risk management strategies.
Knowing that larger losses require exponentially larger gains to recover can help traders make more informed decisions about their trades and risk exposure.
▮ Illustrating Risk Asymmetry
To illustrate risk asymmetry, let's consider an initial investment of $1000.
The table below shows the required gain to recover from various percentage losses:
Explanation:
- Loss (%): The percentage loss from the initial amount.
- Value Lost ($): The lost monetary value from the initial amount.
- Amount After Loss ($): The remaining amount after the loss.
- Required Gain for Recovery (%): The percentage gain required to recover to the initial amount.
This table highlights the asymmetry in trading losses and gains.
As the loss percentage increases, the required gain to recover the initial amount increases disproportionately.
For example, if you lose 50% of your initial amount ( $500 ), it is not enough for you to gain 50% , because the amount left after the loss is $500 , and a 50% gain on the amount of $500 is $250 , which would result in a total amount of $750 with a remaining loss of $250 !
So, the most important question is not how much can I win , but how much can I lose .
Curiosity:
Why 100% is not applicable (-) in this table?
When you lose 100% of your investment, you have lost all your capital. Therefore, there is no remaining amount to recover from, and it is impossible to gain back to the initial amount from zero. This is why the required gain are marked as not applicable.
▮ Conclusion
Understanding risk asymmetry can help traders in several ways:
1. Risk Management:
traders can set stop-loss levels to limit their losses and avoid the need for large gains to recover.
2. Position Sizing:
by understanding the potential impact of losses, traders can size their positions more conservatively.
3. Psychological Preparedness:
knowing the challenges of recovering from significant losses can help traders maintain discipline and avoid emotional decision-making.
It is one thing to lose 100% of a dollar on a casino bet; it is quite another to lose 100% of a lifetime's worth of capital.
Therefore, the larger the capital at stake, the smaller the amount of money that should ideally be risked.
