Mon. Dec 6th, 2021

Last updated on July 16, 2021 by Alphaex Capital

Is true:

Risk management plays an important role in your business success.

However, there is one metric that most people analyze.

In today’s article, you’ll find out what the risk reward ratio is and how it’s included in your negotiation.

Check it out:

What is the risk-reward ratio?

This is a metric to see the risk you take for each operation. The risk-to-reward ratio is measured as the potential profit divided by the potential loss in its operations.

You want to find a balance that minimizes risk while maximizing trading opportunities.

How is the risk reward ratio used in your trading?

– The risk reward ratio should be the first one you calculate before performing any operation.

– Calculate it every time, even if you are sure of your prediction. It’s easy to lose sight of how much profit or loss a particular trade will gain and get carried away by greed.

– The risk reward ratio is one of the best ways to create a successful plan. You should set your risk reward ratio before you start trading so that it does not get too high or low over time.

What is the formula for the risk-reward ratio?

The formula for the risk-reward relationship is simple.

Just turn risk / reward writing into reward / risk.

This will give you a proportion that will allow you to identify the risk you are taking for benefits.

What is the risk?

Risk measures the market value that will be lost in a transaction.

This is usually the distance of your stop-loss.

For example, if your stop-loss is 50 pips, your risk is 50 pips.

What is the reward?

The reward measures the profits made in an operation.

This will be set by your profit order.

For example, if your profit is 100 pips, look for 200 pips.

Therefore, the ratio will give you a format like this:

1: 2.

1: 2 means you are risking 1 pip to get 2 pip.

How is the risk reward ratio calculated?

Finding out the risk-reward relationship is very simple.

All you have to do is follow this simple approach:

  1. Take the phrase Risk / Reward
  2. Turn Reward / Risk around
  3. Enter your pips
  4. Answer the equation
  5. Add “1” before the answer.
  6. It produces the proportion.

Or in other words:

Reward / Risk = Risk Reward Ratio.

So if you look for 250 reward pips and a 20 pips risk, you get 1: 12.5

Accordingly, we continue with the above example:

If you risk 10 pips to get a 100 pips profit, what would you give?

  1. Risk / Reward
  2. (Flip) Reward / risk
  3. Input: 100 pips / 10 pips
  4. Answer: 10
  5. Add 1: 1:10
  6. 1:10 risk reward ratio.

Do you get it?

What is a good risk reward relationship?

The proportion of risky rewards is an important concept to consider when trading forex. Many beginners in the field will think that high risk means higher returns, but this is not always true.

In general, a risk-reward ratio of approximately 1: 2 is considered average in terms of currency trading.

But don’t look at that figure.

Because you can get a 1: 2 risk reward and still not be profitable.

Risk reward ratio in foreign exchange trading

What is a bad risk reward ratio?

A risk-to-earnings ratio of more than 1: 0.25 means you risk more than you have earned so far with this benefit.

It means you are at risk of having 1 pip for 0.25 pip.

These are usually aimed at scalpers, but are more likely to be prepared for this.

So if the ratio was 1: 0.25, it would mean that for every $ 100 you risk you want to earn $ 25.

A better way?

After all, it is NOT the proportion of risk reward that makes you money, but your real business …

However, what you need to do is not limit your profit potential.

This can be achieved in two ways.

First, the most basic is a final stop loss.

Have you ever made a profit with your predefined benefit level just to see it go further and further, and think:

“Damn, I hope to continue in this trade.”

If so, a final loss can help.

A final stop loss means that instead of a fixed stop loss, the price action will follow upwards.

This is a great tool for these key reasons:

  • You can stay in your trade as long as possible until the market “expels” you following the price.
  • Never miss out on opportunity costs to get early benefits.
  • You don’t know if you get benefits at the best opportunity or at the worst (if it keeps rising).
  • You could have entered the lowest point of the market and left too early, thus losing the rest of the trend.

But the subsequent losses are not for everyone, some traders find the pressure to stay in one trade above their excessive profits to manage them or they want to move the margin to another potential trade.

Secondly:

This is what I think is the most important money management tool available.

You can use Kelly’s Criterion to improve the size of your position based on your business performance.

This is based on the theory that by increasing the size of your position in proportion to the probability of success, the return of a winning transaction will outweigh the losses from trading too small and you will also gain better control of the risk that you only bet on one unit size per trade.

The result is that, over time, your average earnings-to-losses ratio will naturally exceed 2: 1.

It’s how big boys trade and you can use it too.

Read our full article on Kelly’s Criterion here.

But what you choose for risk is your thing.

We learned a lot about risk-reward ratios and how to calculate them.

We should all be looking for the best possible relationship that works for us, but what is considered “best”?

The answer may not always be clear, so we wanted to share some interesting ideas on different opinions on this topic.

How do you think your ideal risk / reward ratio would be? Let us know by contacting us through social media.

If you liked this article, you would love one of the other related articles below.



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