FREE FOREX STRATEGIES
Forex brokers comparison

Money management system #5 (Winning risk : reward ratio)

Risk/reward ratio is one the most influential parameters of any Forex system.
A good risk/reward ratio is able to make an unprofitable system profitable, while poor risk/reward ratio can turn a winning setup into a losing strategy.

What is risk/reward ratio?

Risk - simply referred to the amount of assets being put at risk. In Forex it is the distance of our Stop loss level (in pips) multiplied by the number of lots traded. E.g. a stop loss at 50 pips with 2 lots traded would give us a total risk of 100 pips.

Reward - the amount of pips we look to gain in any particular trade - in other words the distance to a Take Profit level.

Example of risk/reward ratio:

100 pips stop vs 200 pips profit goal gives us 1:2 risk/reward.
25 pips stop vs 75 pips profit gives 1:3 risk/reward ratio.

Why consider risk/reward ratio at all?

An average trading system which is able to produce at least 50% of winning signals automatically becomes profitable if its stop and profit targets are set at 1:2 risk/reward ratio or higher.

On the other hand, a trading system which is capable of delivering over 70% of winning signals can still be unprofitable in the long run if it shows poor money management with, for example, 3:1 risk/reward ratio.

Small risk - large reward: a winning formula used by professional traders

How do they do it? Let's review some practical examples:

With low risk : high reward entries at the re-test of trend line, experienced trades can allow to be wrong multiple times before pulling out a winner, and still end up in profit.

Risk:reward ratio trend line Forex

Channeling, range bound markets also offer low risk : high reward trading opportunities. Besides, it is not only about getting in/out of a trade, but also about reviewing previous trends and positioning yourself in the direction of the most likely breakout, and in this way seeking additional profits plus once again eliminating the risk of stops being hit.

Risk:reward ratio range bound market Forex

Wave traders like to ride market trends by entering on price retracement levels. These levels can be found using various studies and indicators: Fibonacci levels, support/resistance levels, trend lines, moving averages, which are treated as flexible trend lines, etc. All these studies help to see the points of retracement reversals.
When doing complex analysis of a retracement, special attention is paid to those price levels where two or more studies coincide in place and time with each other.

Risk:reward ratio complex analysis Forex

No matter what trading system you use, if you make sure your risk:reward ratio is set properly, you'll be trading on a profitable side, even when the number of your losing trades is greater than the number of winning trades.

Risk:reward ratio moving averages Forex

Happy trading!


Edward Revy,
http://forex-strategies-revealed.com/

Copyright © 2009 All Rights Reserved

Sorry to disappoint you but it just isn't that easy...
If you set your SL to 20p and TP to 80p you are much more likely to hit your SL
before hitting your TP even though your system would give correct signals 50% of the time.

Thank you, that's a good point. I'm not saying it is easy. I'm giving an advice to follow in order to maximize chances for successful Forex trading.
Entering somewhere and setting SL to 20 and TP to 80 won't work, you are right about that.
The most challenging part is to get into a position at the best possible level and set the smallest stop possible. In order to do that with maximum precision one has to know a lot about markets.

Even when your trading sheets start looking like this: L L L L L W L L W L L L W, you can easily be a happy and profitable trader, because not the number, but the size of the Wins and Losses matter.

Best regards,
Edward

That's true. The best forex system is "Risk and Reward Ratio". Without Risk and Reward Ratio you just make your broker rich.

Great visuals of risk and reward. The best I have seen on risk and reward.
Great way to teach this important fact. It is something you can imprint on your mind to act upon when these setups avail themselves with low risk. Thank you,
thank you, thank you!!!

Additonal reference here at:
Forex Risk-Reward Folly

You also need to take into account the statistics of the matter. For example, a 25pip stop and a 75pip profit is 3:1 as you said above. But it is no good unless you are wining MORE than 25% of the time. Exactly 25% of the time would be breaking even and less than would be making losses. Simply adjusting the ratio may not help either as it was pointed out before that a closer mark (whether stop or profit) would be hit more often that one set further away.

Thank you!
Good point as well. There should be a balance.

On the other hand, if you win only 25% of the time, your system is probably not the most effective one; unless, of course, your risk:reward ratio averages at 1:10 (seldom proportion to illustrate the main point).

Regards,
Edward

Thank you for showing the risk reward ratio based on the graph or chart. I think I would give it a try. For me, it shows how confident or comfortable are you when you start to make an entry for a buy or a sell position.

For a long term playing forex,

For example:
win small piece, loss big piece, e.g. SL40, TP20.
Developing a lack of confident in future.
In which next time you may consider, SL100, TP10.
Since TP10 easy to achieve than the TP20.

or
win big piece, loss small piece, e.g. SL20, TP40.
Developing a full of confident in future.
In which next time you may consider, SL10, TP100.
Since TP100 you know how to achieve.

This is how I see.

Regards,
Steven