A forex trader will often encounter the term ‘risk/reward ratio’. What does this tem actually mean? Would understanding this ratio bring a lot of profit to a trader?
Definitely
Risks are part of trading, and each trade will bring its particular level of risk. Forex is a world of risks, possibilities and probabilities. As a trader, you should know the risk amount that a trade has. By doing so, you can limit losses, and you’ll protect your trading account. The risk/reward ratio is one of the best tools for risk management, and it’s best to know more about it.
Here is more information about the risk/reward ratio.
Risk/Reward Ratio Definition
The risk/reward ratio is a term used by traders and investors to compare an investment’s expected returns to the risks taken to get these profits. It’s a parameter that determines a trade’s risk levels. It shows how much you’ll be risking compared to your potential profit or reward on a certain trade.
This ratio applies to the trade’s stop loss point, and the exit or target point of a trade.
How to Determine Risk/Reward Ratio
This ratio is mathematically calculated by the manner it’s written: you have to divide the amount of money a trader stands to lose if in case the price will move to an unexpected direction (the risk) to the profit amount the trader will expect to make if the price goes well, and the position is closed (the reward).
A Good Risk/Reward Ratio
The minimum forex risk/reward ratio is 1:2. A larger trade will be better, preferably. For beginners, an acceptable ratio is 1:3, and a lower ratio is more risky and should be avoided. Don’t go into trading if the risk is equal to the reward, perhaps 1:1, as well as a trade where the risk outweighs the reward.
Some experienced traders won’t enter trades if the ratio is not 1:5 or higher. It might take a while before they can find such trade, but the profit can be really worth it. A higher ratio is advisable: if the currency pair won’t make your expected price movement, you’ll still gain profits from it. A lower ratio will have smaller chances of profit, and higher risks will take place.
Importance of a Good Risk/Reward Ratio
The risk/reward ratio is an important trading tool, and it’s necessary for starting traders to take some time in performing this task; it helps minimize risk in trading.
Waiting for a good risk/reward ratio is tedious and time-consuming, but the rewards are endless – definitely worth the patience and the effort. You’ll find the risks involved and you’ll be likely predicting the potential profit. You’ll also realize if the trade you’re getting in is worth the money you’re spending.
Content source: www.admiralmarkets.ph