Question

Weighing risk vs reward is a major part of finance. However, it is also tied to your personality, Imagine I made you an offer: Flip the coin below 3 times...then if you get 1 bear or more in the results I will double your money if you get 2 bear or more in the results I will increase your money 10x if you get exactly three bears (so 100% results is a bear) I will increase your money 100x You can only choose one above, but you can bet any amount of money you want. Which would you select and how much would you risk? Expla

in your answer

Answer 1

risk reward ratio depends on the risk taking capacity of the individual, they can be classified as follows

1. Risk Averse

2.Risk loving

3. Risk neutral

risk averse are those who want to avoid risk as much as possible and risk lovers are those who accept risk to acceptable level with favourable rewards , risk neutral are those who are neutral to risk when making decisions.

for winning any trade we need to have positive expectency and an edge in the trading strategy,

We have Positive expectency when the gains from the trade will recover loss as well as surplus profit

in the given case , based on your risk appetite you can go for the 3 types

risk averse may choose 1 out of 3 bears for a risk reward of 1:1

risk neutral may choose 2 out of 3 bears for a risk reward of 1:10

and risk loving may choose 3 out of 3 bears for a risk reward of 1:100

we can even calculate probablities and increase our changes of winning , but its clearly evident from the outcomes that 1 bear out of 3 has high probability followed by 2 bear & 3 bear . here probabiliites calculations can be avoided as the frequency of the trades is very less so probabilities doesnt may major role. Probabilities have high accuracy when their is high frequency rate ie your winnings will be equal to the calcualted probabilities when their are high frequency ie if the same coin is flipped for 1000 time with same risk reward ratio then we can depend on the outcome of the results based on probablities.

Conclusion: the decision to choose which trade depends upon your risk apetite and the expectencty rate