Why? Let's start with a simple game and you will see the reason.
If there is a game you have more than 60% of chance of doubling your money and 40% of chance completely losing your money, is it a fair game? Of course not to the other party! Just think about casinos, for any game you play, your winning chance is less than 50%! Would you love to participate in this game? Absolutely yes!
Now the practical yet important question - if you start the game with $100, how much would you bet each game, in order to maximize your long term results?
100%? In game one, if you are lucky, you could double your money to $200. Now in game two, since you believe your chance of winning is above 50%, you bet 100% again, and you are right, you win and now you have $400! In game three, are you still all in? Unfortunately this time your bad luck comes, that 40% hits you, and you end up with $0 since you will lose all of your bets!
So not 100%, how about 99%? 90%? 80%? 50%? What's the optimal rate?
Now do you see the importance of Risk Control?
Using mathematical terms, if you face a game with probability p winning and probability q losing, with Rw as your net winning rate and Rl as your net losing rate (in the above game, Rw=1 and Rl=1), what's the optimal % of your principal you should bet in each game in order to maximize your long term payoff?
We will introduce the answer in the next blog post.