The Key to Becoming a Professional Trader

What is the key to becoming a professional trader?

What is the one factor that separates the professional trader from the amateur trader?

In my view, the reason is only one.

The professional trader understands the concept of reward to risk.

The amateur trader does not understand the concept of reward to risk.

Let me give you an example.

Let's say that you decide to take 10 trades and on each of those 10 trades, you decide to risk a fixed amount of money.

Say for example, you decide to risk 1000 rupees on each trade.

1000 Indian Currency.

And let's say that you will not take a trade unless it offers you a reward to risk ratio of minimum 2.5.

This means, on each trade you are risking 1000 rupees.

But if that trade hits your profit target you will at least make 2500, which is a reward to risk of 2.5.

This means, if your trade hits your stop loss level, you will lose 1000 rupees.

If your trade hits your profit target, you will make at least 2500.

That's how you set up these 10 trades.

Now, let's say out of those 10 trades, seven trades go wrong, and three trades go in your favor.

What's your net result?

On the seventh trades that you lost money, your total loss is 7000 rupees, because all of those have hit your stop loss.

However, on the three trades that have made money, you have made 2500 multiplied by three which is 7500.

So net net, if you see, you have made 500 rupees as your overall profit.

Even though seven out of 10 trades have gone wrong, you are still in the money.

This also means that you win, even if you are right only 30% of the time, provided the reward to risk on each trade that you take is at least 2.5.

This is the power of the concept of reward to risk.

You will not have to be right every time in the market to generate a profit.

You can rely on the concept of reward to risk to work in your favor.

Even if three out of 10 trades go wrong, you are still safe.

And by the way, I'm not considering brokerages, commissions miscellaneous charges and taxes in this example.

If you consider those factors, then you would probably need a higher reward to risk ratio.

Because always remember, as a professional trader, you should be aware that, whether you make money on a trade or whether you don't make money on a trade, you still have to pay the brokerage fees and transaction taxes.

Thank you.

Regards,

Rohit Musale, CFA

6 February 2023