Step 5 – Risk reward ratio

Risk reward ratio

When trading any Forex strategy you will first need to understand the concept of risk reward ratio.  Without knowing where to put your stop loss and how much of your account to risk when trading, you will be unable to trade Forex successfully.

In the charts below you can see two examples where I have entered a trade using the false breakout style and the simple breakout style of trading.

risk reward ratio picture 1 risk reward ratio picture 2

The chart on the left shows a simple breakout trade.  The sellers have made a shallow retracement before the market has retraced upwards and passed through an area of supply.  When trading with a simple break out style we measure our stop loss at half of the retracement.

As you can see on the left chart I have marked the area where I entered the trade and where I have placed my stop loss.  Using the simple breakout style your stop loss will always be in reference to the retracement that came before it.

In the example on the right we have a deeper retracement where the sellers push the market down a lot further before the market comes back up to the original area of supply.  Using the false breakout style we use a different risk reward strategy.

When we are trading a false breakout style we always put our stop loss above where the tail reached.  As you can see in the chart above I have marked the area where we would place our stop loss when using the false breakout style of trading.

When trading the Beginners forex strategy you should be aiming for a minimum of 1:1.  This means if you risk $100 you should be targeting a $100 profit at a minimum.  So for example if you risk $100 at 20 pips you will need the market to move in your favour 20 pips to receive $100 of profit.

Everything I have taught you so far has been to give your trades the best chance of moving in your favour for as long as possible.  This is achieved by measuring the likely strength of the market based on your analysis of supply and demand.

Even after we have used all of these methods to analyse the market, there is always a chance that the market can turn around against us.  This is why I say that a 1:1 risk reward is a good place to exit your trade.  If anyone ever tells you that they do not need a stop loss because their trading method will never lose, let me assure you they are either deluded or outright scammers.

No one is ever right 100 percent of the time with their trading and it is accepting the losses you will inevitably have that will develop you into a realistic well rounded trader.  Using my strategy you will only need to be winning 55 percent of the time to be profitable.  So whenever you take a loss in Forex don’t get frustrated as it is all a part of being a successful trader.

The percentages I would recommend risking when trading range from half of a percent up to 5 percent.  This will depend on how frequently you like to trade and how this fits with your personality.

For example if you would like to trade every few weeks if not less well then you can afford to risk a higher percentage of your account.  But if you are the type of trader who likes to trade every day, you should be risking a smaller percentage of your account.

These are guidelines I would recommend and should not be set in stone.  Ultimately it is your own responsibility as a trader to risk sensible amounts that won’t cause you too bigger drawdown on your account.  (A maximum drawdown is the lowest point your account reached over a given period of time).

Appling the techniques I have presented in this article will allow you to trade with an excellent money management strategy.  As you become more familiar with risk reward you will begin to adjust the percentages you risk to what suits the time frames that suit you.

Once you have mastered risk reward ratio you will never have to worry about a trade ever again.  As you will not be risking percentages you can’t afford and you will understand that losing trades are a part of learning to trade Forex.

 

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