Risk Reward Ratio (or known as RRR) is a very important topic for traders regardless what instrument you are trading. In the following article, we will discuss how risk reward ratio will affect your trading result and how you want to track and improve your RRR.
What is Risk Reward Ratio?
Investing money into the market always carry certain degree of risk, and if you’re going to take the risk, the amount of money you stand to gain needs to be bigger than the amount you are risking. This ratio is calculated mathematically by dividing the amount the trader stands to lose by the amount of profit the trader expects to have made when the position is closed if the price moves against him/her.
For example we are entering the short trade on the resistance. At that point, the risk reward ratio is 2:1 (60/30) and our minimum required winrate is 50%. If you are entering a trade at 1.0000, your Stop Loss is 1.0030 to ensure you won’t lose more than 30 pips and you should place your take profit point at 0.9940. This is the illustration of good trade of RRR 1:2.
Let’s say we have balance of $1000 in trading account. Unless you’re an inexperienced investor, you would never let that $1,000 go all the way to zero. Your actual risk isn’t the entire $1000.
Every investor has a stop-loss, or a price on the downside that limits their risk. If you set a 0.9940 as the target, maybe you set 1.0030 as the maximum downside. Once your stop-loss order reaches 1.0030, you close it and look for the next opportunity. Some investors won’t commit their money to any investment that isn’t at least 1:3 or 1:5, but 2:1 is considered the minimum by most. Of course, you have to decide for yourself what the acceptable ratio is for you.
Next, we will talk about how to spot a good risk reward trade in both stock market and forex market. Stay tuned.
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