If you’ve done any research online about Forex trading you have undoubtedly heard of risk vs reward or risk:reward ratio.
In this article, I will explain what is risk/reward ratio and how you can find the risk/reward ratio that is right for you.
What Is Risk/Reward Ratio?
The risk vs reward ratio is a formula that helps a trader determine how much money a trade is risking to make the profit it will make – It’s really as simple as that.
For example, you have $1,000 in your account and you decide to risk $10 on a trade. By studying a Forex chart you decide that your stop loss needs to go about 20 pips away. So your risk for this trade is $10.
The Forex chart also tells you that there is a likely reversal point about 40 pips from where you’re entering the trade, so you decide that 40 pips is a good place to put your profit target. So, your stop loss is 20 pips away and your profit target is 40 pips away.
As your profit target is double the distance of your stop loss and your stop loss is a risk of $10, you should profit $20 if the trade hits your profit target (minus spread / commissions). So your reward for this trade is $20.
This means that you had a risk of 1 and a reward of 2, or a 1:2 risk:reward ratio.
Is There a Good Risk/Reward Ratio?
Not really, as it comes down to your Forex trading plan and strategy, your emotions and your money management.
For “normal” Forex trading strategies you should always try to have a smaller risk than your reward but there are many strategies that defy this.
In general, if you are a new Forex trader your job is to preserve your capital whilst learning and the best way to do this is by maintaining a low risk and high reward in your trading – otherwise you’ll find yourself on a downwards sloping path to blowing up your trading account.
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