Prediction markets have become a popular way of making money. Most people, especially newbies, have lost hundreds if not thousands of dollars because they failed to evaluate the risk associated with prediction markets. Enormous profits in the space attract everyone, but many fail to understand that those who succeed have years of experience below their belts or a team of professionals helping them with the trade.
Risk and reward are fundamental in any form of trading. Risk is the money you lose in a given transaction, while the reward is the profits you get in a trade. It is prudent for a trader to understand the risk/reward nature before indulging in trade.
The risk/reward in prediction markets is fixed. Profits and losses correlate with the range of floor to ceiling fixed between 0 to 100. It, therefore, puts the probability against a trader depending on two outcomes – either the contract expires with prices on the predicted terms or the opposite side. In options trading, the risk is pegged to the staking amount, and the trader will lose their trading amount when the price of an underlying market goes against their predictions.
Understanding the Risk/Reward Ratio
It is crucial to understand the risk/reward ratio of the prediction market before pressing the buy or sell button. Understanding the ratio will help you to minimize risks while capitalizing on rewards.
In other forms of trading with leverage like Spot Forex, the risk/reward ratio is different from prediction markets. They allow you to stop loss through stop-limit order; you can fix this ratio as you wish. These features are not available in prediction markets.
The risk-reward ratio is the rate between the potential risk and reward in any given trade. In prediction markets, the probability of winning or losing on trade is 1:1. This means that either you profit in trade or lose your position. Let’s have a case scenario to make things skin deeper.
Assuming that the oil market is thriving and anticipating a pump in oil prices in the coming days, you buy on the underlying asset. Once you open an option on oil, there are only two likely chances; either the price goes your way, or it doesn’t.
If you decide to stake $100 and buy oil, you will gain profits on a fixed percentage when the market remains bullish up to the date of expiry of your trading contract.
Prediction markets have varying reward systems, but earnings in these might go up to 92%. This means that you will earn a maximum of $92 in profits if the oil market remains on an upward trend during your trading period. If the price dips against your prediction, you will lose 100% of your stake. The profits and losses are dedicated to your trading account when the trade expires.
Two main factors influence an outcome in prediction markets. These include the win-loss ratio and the risk-reward ratio. It is ideal to trade on an underlying market or asset with a risk/reward ratio of 1:2 in prediction markets. The win-loss ratio is the rate of winning or losing a trading position. It is usually represented as a percentage.
It is beneficial for traders to understand the risk/reward rates while trading on prediction markets. Here is are some of the benefits:
It helps you in minimizing risks while maximizing profits.
It will enable you to think of good trading strategies.
Understanding the rates is fundamental in planning your portfolio, and it also facilitates diversifying trading positions.
How To Get a Better Risk/Reward Ratio
There are various ways to get a better risk/reward ratio. You might want to look for a trading platform with flexible trading terms and conditions accompanied by other offers.
On the other hand, there might be trading platforms that allow you to sell your contracts in a case where you feel that the market will go against your prediction. Selling a trading contract affects the rewards. Your profits will be reduced, but at least you will not lose the entire investment. Such features brokers help traders exit a losing bet, minimizing the risk of being liquidated.
An effective trading strategy is the other way to achieve a better risk/reward rate. It will help develop a plan that capitalizes on profits while reducing the markets’ risks of wrecking. Most traders get liquidated in prediction markets for not having a good trading strategy. They end up loosing their capital as they gamble through the markets.
It is not easy to predict the price movement of underlying markets due to market volatility. Prices keep on fluctuating, making it hard to tell the market movements. It is essential to understand the risks/reward ratio before making a trading decision. In most cases, the risk/reward ratio favors the brokers; you need to think outside the box to beat the brokers.
Finally, it is prudent to avoid trading with emotions. Going for the trade while focusing on the rewards can blow up your trading account, for you might not see the risks approaching.