10. What’s even scarier is takings risks without taking into account the costs…

Successful traders, like Einstein’s “God”, don’t play dice games — they avoid things that are purely decided by chance.

Even if they sometimes accept risk, the risks they accept can only be for decisions in which “the odds of winning exceed 50%”, or, in the best case, “the odds of winning are much better than 50%”.

Leeks are different. They like taking risks, but they don’t even know how to calculate risk. Yes, risk can be mathematically calculated! But leeks have never calculated it, and they’ve never even thought that they should calculate it. So do you think they can win? If they did win, wouldn’t that violate heavenly principles?

You’re a novice, not a leek, or at least you don’t want to alway be a leek. So what should you do?

Learn!

You don’t want to learn? Is there anything else you can do? Yes — exit the market, and never participate.

So go ahead and learn, until you’ve turned yourself into a straight A student.

Somebody borrows money from you — 100 RMB — and tells you that they’re willing to pay you back 110 RMB when the loan is due. What is your risk/reward ratio at this time? Your risk is the person disappearing and your losing 100 RMB. Your potential return, if the person returns your money, is having 10 RMB more than you had before. So your risk/reward ratio is 1:0.1, or 10:1. This doesn’t look very attractive at all!

If the other person told me that they would borrow 100 RMB and return 150 RMB to me the next day, then I would definitely not lend it to them, because these are terms that only a gambling addict who was in a hurry to play Mahjong would propose… I don’t have friends like this! All joking aside, let’s return to the essence. Actually, when you aren’t sure of the creditworthiness of the other party, no matter if your reward is 10%, or 50%, or 200%, your risk is the same: the most you can lose is your principal of 100 RMB. The risk/reward ratio is very different, but this ratio has a very different influence on your state of mind.

A bit confusing? Don’t worry, in the beginning piling up several layers of simple things seems very complicated and not very intuitive. Reading multiple times is the key to reading any book.

In the above example, the actual cost comes from the the pressure you feel from the “identical risk” — that you might lose 100 RMB. If it turns out that your monthly income is six figures, then you might even say to the other party, “Forget it, there’s no need to pay me back!” If you’re a poor kid in university who totally depends on support from parents, then 100 RMB might be your meal fee for a whole day. If it happens to be the end of the month, and all you have left is your last 100 RMB, then that cost is completely unbearable for you.

So you can see that there are many factors to consider in calculating the cost of risk, but your strength is most important, followed by risk/reward ratio. See, it’s the same everywhere: strength is most important.

Let’s switch scenes to trading markets.

You see a target, X, that has dropped from a high of 26 RMB to 20 RMB, and you guess that it is likely to go back up to 22 RMB, and at that point you can “cash out”. So you use 500 RMB to buy 25 units. So, what is your risk/reward ratio? Shall we calculate it?

The denominator is your potential return. Once the price has returned to 22 RMB, your total potential return is 50 RMB, while the total amount you have “taken a risk” with is 500 RMB. So your risk/reward ratio is 500:50, or 10:1. How does this ratio look? It’s actually not that great, is it?

But this calculation actually needs to be improved. Because novices don’t set stop loss lines. Or, to be more precise, “leeks” don’t have the concept of “stop loss”. You are different, as you’ve learned and you know you should set stop loss lines, so you set one for yourself: if the price drops to 18 RMB, then you will sell no matter what.

Now, what is your risk/reward ratio? The denominator is still 50 RMB, but what about the risk? The risk is 500 > - (25*18) = 50. So it’s 50:50, equivalent to 1:1… How is this different from flipping a coin? Why would you go to a trading market to flip a coin?!

Furthermore, this is still different from flipping a coin! Trading markets have fees whether you buy or sell, so if you take trading fees into consideration this trade is worse than flipping a coin and betting on heads or tails!

The reason that leeks are leeks, and will always be leeks, is that not only do they take risks, they also don’t calculate the costs of those risks. Even more tragic is that they have never even thought that they should make these simple calculations… They also learn, but what they learn is to “seek out gossip”.