🔸UNDERSTANDING RISK TO REWARD AND HOW TO CALCULATE IT 🔸
A detailed Thread 🧵
A detailed Thread 🧵
The risk-to-reward ratio is a crucial concept in forex trading. It is calculated by comparing the potential loss (risk) to the potential gain (reward).
This ratio helps you assess whether a trade is worth taking based on the potential rewards and the associated risks.
This ratio helps you assess whether a trade is worth taking based on the potential rewards and the associated risks.
A common way to express the risk-to-reward ratio is as a ratio, such as 1:2 or 1:3. For example, a 1:2 ratio means that for every dollar you are willing to risk (potential loss), you aim to make two dollars in profit (potential gain).
Calculating the R-to-R ratio, you need three key pieces of information: entry price, stop-loss level, and take-profit level. The entry price is where you enter the trade, the stop-loss is where you'd exit to limit losses, and the take-profit is where you'd exit to secure profits
Start by subtracting the stop-loss level from the entry price. This gives you the "risk" in terms of pips or price movement. For example, if you enter a trade at 1.1000 and your stop-loss is set at 1.0980, the risk is 20 pips.
Next, subtract the entry price from the take-profit level. This gives you the "reward" in terms of pips or price movement. If your take-profit is set at 1.1100, the reward is 100 pip
Now, divide the risk by the reward to get the risk-to-reward ratio. In this example, the risk-to-reward ratio would be 20/100
Sl is 20 and Tp is 100. 100÷ 20 = 5
Risk to reward ratio = 1:5
Sl is 20 and Tp is 100. 100÷ 20 = 5
Risk to reward ratio = 1:5
Using the above price let's calculate the potential profit or loss on a $100 account risking 6% per trade.
6% = 6$
Next is to get the right lotSize for a 20pip sl = 0.03
Because 0.03 lot size to 1 pips is 0.3 cents = 0.3 × 20 = 6 ( Risk )
6% = 6$
Next is to get the right lotSize for a 20pip sl = 0.03
Because 0.03 lot size to 1 pips is 0.3 cents = 0.3 × 20 = 6 ( Risk )
Now that we have gotten our risk which = to $6 for one trade and the required lotSize for a 20 pips stop loss = 0.03
Let's calculate our take profit
Simply multiply the risk but the profit ratio which in this case is 1:(5)
= 6 × 5 = $30
Let's calculate our take profit
Simply multiply the risk but the profit ratio which in this case is 1:(5)
= 6 × 5 = $30
This basically means that you are risking $6 to make $30 which also = to 1:5
REMEMBER the smaller the stop loss the more you can accommodate a bigger lotsize.
For instance using the same balance above if we had a 10 pips sl instead we would be able to use a bigger lot .
REMEMBER the smaller the stop loss the more you can accommodate a bigger lotsize.
For instance using the same balance above if we had a 10 pips sl instead we would be able to use a bigger lot .
Let me explain: remember the risk is $6 but this time we have a 10pips sl not a 20 pips. Which means we can use a lotsize of 0.06 instead of 0.03
Our risk is still $6 but the profit is now 60$
So when a trader uses huge lotSize understand that the stoploss may be small.
Our risk is still $6 but the profit is now 60$
So when a trader uses huge lotSize understand that the stoploss may be small.
One of the fastest ways to get your risk to reward ratio is to use the position tool on trading view just like in the picture attached
The tool also shows you your stoploss, take profit and entry price
The risk to reward ratio in the picture is 1 : 3.39 ( very decent)
The tool also shows you your stoploss, take profit and entry price
The risk to reward ratio in the picture is 1 : 3.39 ( very decent)
A higher RR ratio doesn't necessarily mean a better trade. It's essential to strike a balance between the two. A higher ratio might lead to fewer winning trades but potentially larger profits when they occur. A lower ratio could result in more frequent wins but smaller profits.
understanding and implementing an appropriate risk-to-reward ratio is a fundamental aspect of successful forex trading. It allows traders to make informed decisions, manage risk, and potentially increase their chances of consistent profitability.
Remember, forex trading carries inherent risks, and there's no foolproof strategy. Always practice sound risk management and money management strategy
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