The risk-reward ratio measures your potential reward for every $$$ you risk.
Let’s talk examples. For instance, say you have a risk-reward ratio of 1:5, you’re risking $1 to potentially make $5.
Or say you have a risk-reward ratio of 1:10, you’re risking $1 to potentially make $10.
Pretty straight forward right?
But what’s the recommended risk reward ratio in forex?
To put it simply, risk is the total amount that could potentially be lost from a trade.
Reward is the potential profit you could gain from a trade.
The risk/reward ratio is the relationship between these two numbers.
Now that we got the definition out the way, let’s talk business.
To calculate the risk & reward ratio, you’ll first have to establish each og them separately.
The formula goes like this:
If the ratio is more than 1, the potential risk is bigger than the potential reward.
If the ratio is less than 1, the potential profit is bigger than the potential loss.
Take a look at an example below to see the different risk:reward ratios on a forex chart.
Many experts and forex traders believe that if you want to increase your chances of being profitable, you want to trade with the potential to make 3 times more than what you are risking.
This theory suggests that trading with 3:1 reward-to-risk ratio is the right way to go about trading forex!
Let’s see what this would look like in practice by looking at the table below.
You can clearly see that even if you only win half of your trades, you will still end up profitable at the end.
In fact, you’d bag yourself $10,000.
Not too bad, right?
Now, you might be wondering why all traders wouldn’t just go with higher reward to risk ratios.
It’s simply because it is more difficult for the price to reach a higher profit target than it is to hit the stop-loss level.
At the end of the day, your trades need breathing room to cope with all the price fluctuations!
Don’t risk too much money trying to make big profits fast.
Be smart and be patient.
It will pay off!