By ForexCycle.com
More often than not, traders have strategies with over 50 or 60% win rate. Then why is it that most of these traders still end up not profitable in the long run? It all goes back to the risk / reward ratio that a trader employs. If a trader intends to use a 1:1 risk to reward ratio, then the strategy used must be profitable over 50% of the time. Most of the time some traders claim that the reward-risk ratio is not important and that is very wrong and misleading, especially to newbies. Although the reward / risk ratio cannot be of much help on its own, when used together with other trading strategies it really becomes a tool that a trader cannot do without.
Question now becomes, how do you really know what risk to reward ratio to employ in your trading? Well, depending on the type of trader you are, you need to be certain about the win rate of your strategy. It’s from the win rate of your strategy that you can correctly determine the risk to reward ratio to use. A strategy that has a higher win rate could use a lower risk to reward and still remain profitable in the long run. On the other hand, a strategy that has a lower win rate requires a higher risk to reward ratio to be profitable in the long run. Considering all this, a trader can easily arrive at a risk to reward ratio that suits their trading strategies.
Sometimes, as much as a trader gets into a trade with a very good risk to reward ratio, stop loss widening ends up messing with the original risk to reward ratio. This often happens when a trader notices that a trade has gone to the opposite direction and with hopes of a rebound they widen the stop loss. The problem is that traders rarely widen the take profit when a trade goes in their favour! This often leads to poor overall performance. Unless you have a really good reason to widen to stop loss, it’s better to stick to the original stop loss. Better yet, when you widen the stop loss, widen the take profit too to retain the original risk to reward ratio. Most traders think that using a wider stop loss and a closer take profit will increase their win rate but it’s not always that easy.
A smart trader should design a cheat sheet for risk to reward ratio as follows:
| Historical Winrate (%) | Minimum risk to reward ratio |
| 25% | >1:3 |
| 33% | >1:2 |
| 40% | >1:1.5 |
| 50% | >1:1 |
| 60% | >1:0.7 |
| 75% | >1:0.3 |
Sticking to the right risk to reward ratio requires discipline and practice. If you had properly analyzed the market to get a good entry, why should you modify the risk to reward ratio in the course of the trade? If the trade goes against you take the small loss and look forward to the next trade. After all, the profits made from the next trade will cover the losses made by the previous trade and still have some profit on top.
By ForexCycle.com
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