Typically, the calculation of how much you want to earn versus how much you want to risk is the risk-reward ratio. It can be defined as the amount of money that can lose in a single trade. If you are involved in Forex trading, you must know the portion that can be used in each trade. Nobody should risk more than two percent of their capital on a special deal. That means, after finding an accurate place for the stop loss, investors should choose such a position. This selected position can make a loss of two or three percent of the total account balance.
On the other hand, the reward is the specific profit that can be made in a Forex trade. For example, we can tell that, if you want to set the stop loss of five pips and set the target profit at 25 pips, the ratio will be 5:25 or 1:5. In this case, the investor is risking five pips to attain 25 pips. This is the general way to understand this phenomena.
Process of plying the ratio
The fundamental theory for this ratio is to look for new opportunities where the reward can outweigh the possible risk. The account can withstand at any time if the possibility is higher for gaining the rewards. If the same portion is used for a long time, profit loss can happen at any time. But this loss is not crucial for continuing the overall process. Probably you have all come to learn that the process is not an indicator or a trading system. It is the smart way to calculate the take profit and stop loss. Here, the stop loss is the risk, and the take profit is the reward that can be achieved. If the premium is higher, more investment is possible without losing money.
The majority of smart traders in the futures trading industry, always trade with managed risk. They never trade with high risk since they know it can cause them big trouble. To be on the safe side in trading, you should follow the same rules.
The recommendation for getting a better result
If the Forex market starts forming a strong pattern, 1:3 and 1:5 will be the best choice for running trade setups. A suitable timeframe should be selected for trading. Some issues can affect the process such as:
- The traders miss the opportunity to enter a profitable trade
- Current market trends are smaller than 25% of the time
Usually, most investors hesitate to start trading because they want to control the risk, and that is not possible. Sometimes a misinterpretation can happen, and the trade might hit the stop loss point. So, the investors face some losses just because of calculating the risk to reward ratio properly. Usually, experts suggest that a 1:2 risk to reward ratio helps to maximize the profit by reducing the number of losing trades.
The process of calculation
Calculation of the risk-reward ratio is one of the safest strategies used by investors. This calculation will give you an accurate result. The analysis divides the net profit by the highest rate of risk. The main steps that should be followed to calculate the ratio are:
- Do exhaustive research and select the currency
- Look at an overview of the present price
- Setting the upside and downside targets
- Registration to a suitable platform for getting a comparison within the brokers
- Calculating the risk-reward ratio
- Using the pips as the measure
The principle setting of the risk to reward ratio is very simple. You must analyze the investment when the reward is about to offset the risk. When the profit is higher, your success rate will increase. The goals of investors can mitigate the result. The Forex market shows the different conditions, so the traders should be careful about maintaining the risk-reward ratio. This will help to handle the circumstances and avoid massive loss in the market.