One of the keys to money management is applying a proper risk reward ratio in Forex trading. Every trade in the foreign exchange involves a certain amount of risk. So each Forex trader must carefully assess how much risk he can handle before entering a position in order to mitigate losses and protect his trading account. Most traders use the risk reward ratio as a measure of risks involved in a trade, as it depicts how much money is being risked versus the maximum profit or reward. And it proves to be a very important risk and money management trading strategy.
Determine the Risk Reward Ratio in Forex.
First, you need to calculate the amount you are using to trade, which represents the risk. Your total risk is the number of lots multiplied by the cost of the currency. Now, you’ll need to calculate the reward, or the maximum profit you can make from that particular trade. The gain in currency value multiplied by the total number of lots traded is your reward value. Thus, you can easily get the ratio, and determine what’s your next move should be depending that risk-reward ratio calculation.
Example of using Risk Reward Ratio in Forex.
In order to be more specific, let us go through an example. Suppose, your risk value is $1000, and you stand to make a profit of $2500 from that particular trade. Then, your trading risk reward ratio is 2:5. Better Risk Reward Ratio in Forex, usually generates higher profits over the long run.
Traders should basically look for a minimum risk reward ratio in Forex of 1:2. However, a better ratio can be more profitable. Thus, a satisfactory ratio for Forex traders should be 1:3. If you calculate it to be less than that, then that trade should be avoided. That, as it involves more trading risks. Most experienced Forex traders use 1:5 or higher. They do it even if they have to wait for such an opportunity for a long time. The higher reward makes up for the waiting time. On the other hand, exceptions are strategies with a lower ratio, might even be slightly negative. It can be effective when there are extremely high probability trades. These kind of trading strategies might generate decent profits for the short terms.The risk-reward ratio is considered to be an essential risk management tool, and all Forex traders therefore should study it carefully. That way you can mitigate losses,maximize profits, and take better and smarter trading decisions.
Learn also about: Forex Risk Management – Risk Per Trade
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