The Sharpe Ratio that is referred to in the financial world is named after William F. Sharpe, a Nobel laureate in economics. It’s simply a measure of calculation for a risk-adjusted return and is the industry standard when it comes to doing such things. That’s the average return earned in excess of what is considered to be risk free assets. In general, this normally is suggested as US Treasury bills, which is considered to be “risk free.” The Sharpe Ratio works as follows: the average rate of return for your portfolio is subtracted by the best available rate of return of a risk-free security. Then, you divide that number by a standard deviation of the portfolio’s return. Essentially, a return of “zero” is the same as a treasury bill. A number of 1.0 or above is attractive, a return of 2.0 is even better, and one of 3.0 is excellent. These numbers are used to compare one portfolio to another, in order to see whether you are getting acceptable returns for holding risky assets over risk-free assets. Essentially, it’s a way to compare 2 portfolios in an even playing field.

In this video, I talk about risk versus reward. Without a doubt, this is one of the most basic money management fundamentals that you have to follow. The one thing that you have to understand about trading is that you are not going to win all of your trades. The reality is that you are going to have losses from time to time. By using risk to reward analysis, you can help increase the odds in your favor longer-term. For example, if you’re risking 1 in order to make 5, you only need to be in order to break even. However, if you are risking 1 to make 1, you will likely lose money over the longer term as the losses will wipe out gains much quicker. Looking at a few trades, you can see that the first one is a massive hammer that formed at the bottom of the downtrend. This is typically a reversal signal, but if you use classic technical analysis and trading technique, you can see that on the hammer you would have to risk something akin to 550 pips. Now looking at the trade itself, you have to ask yourself how far can this particular pair go? In this case, you can make a real argument for the 155 level, but the problem is that you’re working against the trend. Because of this, you have to take that into account, and you can also find quite a bit noise on this chart at the 153 level, meaning that you are more than likely going to get 250 pips. This is an absolutely horrible risk to reward ratio and therefore this isn’t the type of trade that you want to take as you would almost always have to be correct on these setups.

One of the most recent developments in the trading world is the concept of social trading. Initially, this was found mainly in the currency trading world, but has been adopted by stock traders and commodity traders as well. Essentially, social trading is a place where traders will post their trading ideas, and go back and forth with each other on potential trades. Some places will do it automatically, meaning that there is some type of software that you plug into your trading platform to automatically post positions, while others will rely on you to input your trade. In theory, this is a great idea. However, in practice it is much different. Most people who look at social trading are looking for someone to make their trades for them. In other words, they are waiting for someone to tell them what to do. Typically, what happens is that the new trader will see somebody in the rankings that has made an astronomical return over the last couple of weeks. However, by the time that person gets that high up on the leaderboard, they almost always turn around and fall hard. You will see things like 400% gains in a week, followed by somebody being wiped out. This is because they do not understand leverage, and the new traders that follow them will suffer the same fate.