Risk To Reward Ratio in Currency Trading
Many currency traders find it hard to follow simple risk management rules. Many times, they will turn winning positions into losing ones. They will be surprised to find solid trading strategies result in losses instead of profit.
Most forex traders lose money. They fail to understand and apply proper risk management rules in their trading. Risk management means knowing how much you are willing to risk and also knowing how much you are looking to gain in a trade.
Without a sense of risk management, many traders hold onto a losing position for an extremely long amount of time and take profit on a winning position far too prematurely. The net result is that traders end up with more winning positions than losing ones but their account Profit/Loss (P/L) is negative. Keep these simple risk management rules in mind while trading. Risk-reward ratio is very important for you to know and understand. As a trader you should calculate a risk-reward ratio for every trade that you make. In more simple words, you should have an idea of how much you are willing to lose if the trade goes against you.
Risk to reward ratio depends on how much you are willing to risk in order to make a certain reward. Suppose you are willing to lose 20 pips. You place a stop loss 20 pip from your entry point. This is your risk. Suppose you are willing to make 100 pips. You place a take profit or limit order of 100 pips. This is your reward. So your Risk to Reward Ratio is 20/100=1/5=0.2. Any Risk to Reward Ratio of less than 1/2 or 0.5 is considered to be good. In forex trading, never enter into a trade when the risk to reward ratio is less thn 1/2 . Download this 1 Minute Forex Trading System FREE. Learn this powerful Fibonacci Retracement method FREE that pulls 500+ pips per trade. Get these Swing Trading Informants FREE!
There are two ways to place the stop loss order.
1) Initially place the stop loss at a reasonable level.
2) Trail the stop meaning move it forward towards profitability as the trade progresses.
There are two recommended ways of placing the stop loss order. One involves placing the stop loss order 10 pips below the two days low of the currency pair. For example, if the EUR/USD recent low was 1.1300 and the previous day low was 1.1200, then place the stop loss at 1.1190, 10 pips below the two day low if you want to go long.
The problem with static stop loss order is that they are easily visible to your broker who can trip them. Most forex broker hunt stop losses. What this means is that you should use a dynamic stop that uses something like the Parabolic SAR indicator. Parabolic SAR is a volatility based indicator. You can also use a mental stop loss. This is what most professional forex traders do .