Hello guys! I hope you are all well.
In this post I will talk about risk to reward in Forex trading. I am a firm believer that risk to reward is crucial if we want to make money consistently in the forex market. For you who are already making money consistently, you know what I am talking about. But for you who are still not profitable, this article WILL help you change the way you trade.
In the world of forex trading, many newbie traders think that to make money in forex, they need to have a high win rate. The problem is getting a high win rate is very difficult in forex trading let alone to be right 100%. Everyday newbie traders are seeking for 'the best strategy and indicator' (holy grail) that can give them a very high win rate in trading. Well let me tell you something, such thing does not exist.
My point is this : it is not about how many times you win BUT it is about how much money you make when you win compare to how much money you lose when you take losses. I call it risk to reward ratio. Risk to reward ratio is the key to be consistently profitable in forex trading.
Let me give you an example :
Let's say there are two forex traders, trader A and trader B. In the past 10 trades, trader A managed to win 8 times compared to trader B who won only 4 times. At this point, many people think trader A is more profitable because he has more winning trades than trader B, but let's take a look closer :
Trader A does have 8 winning trades but he still ended up losing money. How come? Every time trader A wins, he gets $1 then when he loses, he loses big, $5. He managed to win 8 times out of 10 (so his win rate is 80%) which give him a profit of $8 but he has 2 losses, and each loss is -$5, giving him a total loss of $10. So trader A's risk to reward ratio is 5 : 1 (very bad). At the end of the day, trader A lose money because his losses are greater than his profit even tough he has more winning trades.
On the other hand, trader B only won 4 times which means he has only 40% winning rate. But as you can see, he still makes money. Every time trader B wins, he gets $2 and when he loses, he loses only $1. Because he only won 4 times, then his profit is $8 (4 x $2) compare to his losses, only $6 (6 x -$1). Trader B's risk to reward ratio is 1 : 2 (very good). At the end of the day, trader B manages to make money, +$2. Trader B is profitable even tough he has a fairly low win rate.
The example above gives you an idea why risk to reward ratio is more important than a win rate. I highly recommend you to just find a really simple trading methodology that can give you at least 45-50% win rate but has a good risk to reward ratio, at least 1 : 1.5 . The higher the reward, the better.
There are so many factors to be profitable in forex trading and having a good risk to reward is one of them. I hope you can learn from this article and will improve in the future. Do you have any experience regarding risk to reward ratio? Or do you have any questions? Just write it down in comment section below.
Good luck, happy trading!