If you’ve been trading for a while, you must’ve heard about risk reward ratio one too many times. All traders and investors use it. But, does it work?
It can be a great tool to improve your strategy. However, you won’t win on every trade with this formula if you use it alone. That’s why risk reward is meaningless if you use it on its own.
If you’re here it means that you want to learn how you can use the risk ratio formula to improve your trading. Not sure it’s worth using it in your trading? We’ll tell you how you can use this concept to grow your account in no time.
Risk Reward: Is It Worth It?
Before we discuss how you can use the risk reward ratio in Forex, we’ll go over the basics. What is a reward to risk ratio?
Your risk reward ratio on a trade is how much you’re willing to risk to make your potential profit. Yet, if you place trades with a 1 to 3 ratio it doesn’t mean that you’re making the most profitable trades. An example is if you use that ratio and place 10 trades.
From those trades, only 6 end up being winning trades. Your winning ratio is only 60 percent. The key to using the risk ratio formula right is having a consistent winning rate.
There’s no end game rule when it comes to how much you should risk making profitable trades. Every trader has their own risk profile. They should follow it to make the most out of their trading.
You might use a 1 to 0.5 risk reward ratio and be profitable in the long run. It will depend on your winning rate. Using this formula is like a marathon, not a sprint.
How to Improve Your Strategy Using Risk Return Ratio?
Your winning rate and risk reward ratio aren’t the only metrics you should worry about. It’s important that you set your stop loss and define your risk profile. If you’ve been trading for a while, you know how much risk you can handle.
However, your stop loss shouldn’t be set at a certain number. You should use forex indicators such as moving averages, trendlines, among others as your guide. This data can help you set a reasonable stop loss by using the market structures.
Your stop loss will help you calculate your position sizing. That’s the best way to minimize your losses. To calculate it, you’ll divide the amount you’re risking over your stop loss times the value per pip.
The result equals the number of Forex lots you must trade for the amount you’re risking. To use a risk ratio formula, you have to define your reward. The way to define it is by setting your target profit at a level that the market can reverse it.
You should consider taking the profits at a certain side of the strategy. An example is when you use support and resistance. You could consider taking the profit at the resistance or support side depending on the position you’re holding.
Can Using the Risk Reward Ratio Grow Your Account?
Yes, using risk reward in your trading strategies can help grow your account. The key is not using the risk ratio formula alone.
You must define your risk and reward structure. But, you have to use it in your strategy. It will all come down to our trading strategies and the positions you’ll hold.
Want to learn other trading strategies to take your account to the next level? Check out our blog post to learn more.