Risk Reward Index It is the profit or loss ratio and an indispensable factor in Forex trading, related to the management of investors' capital and also a factor for verifying the effectiveness of trading, assessing the long-term profitable capacity. However, there are many traders, especially those who are new to the market, who do not give importance to this factor and have wrong views when setting profit and loss ratios in their strategies. So what is the risk reward ratio? Why the profit/loss ratio matters when trading at the most reputable forex brokers. Let's learn more about the Risk Reward Index with Portalderendaextra
Learn more about the Risk Reward Index
When a trader implements a specific trading strategy, the relationship between the potential profit that can be achieved and the level of risk he accepts to lose by making that trade. In other words, the Risk:Reward ratio tells the trader how much profit he will make on a successful trade or how much he will lose if he fails. Traders usually just write Risk Reward or abbreviated R:R.
How to calculate risk reward
The R:R ratio has a very easy calculation, which is the ratio between Stop-loss and Take-profit.
Risk: Reward Index = Stop-loss/Take-profit
Example: A trading strategy with a stop-loss of 30 pips and a take-profit of 90 pips. So the R:R ratio of this strategy is 30/90 = 1/3 or 1:3. Let's take an example of the R:R ratio in a specific transaction.
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Once the market makes a new low and the new high is higher than the old low and high, you know that the market has moved into an uptrend. You draw a rising price channel as shown and think about placing a BUY order on the channel's support, Stop Loss on the closest bottom and Take profit on the channel's resistance.
After determining the order position, you can calculate where Stop Loss is at 220 pips from BUY, Take profit is at 550 pips from BUY. So you calculate Risk Reward = 220/550 = 1/2.5. To summarize this trade, if you lose – lose 1 share, if you win – get 2.5 shares.
Relationship between Risk Reward and Win Rate
Two important factors in forex market trading and you need to balance these two factors correctly are Risk Reward and Win Rate. Typically, traders only care about Winrate (probability of winning) and not much about Risk Reward (risk/reward). However, the relationship between Risk:Reward and Win Rate in trading is an opposite relationship. If you want a high win rate, the risk reward will usually be low, and vice versa, if you want the risk reward to increase, the win rate will decrease.
So what needs to be done is to find and maintain a suitable position between Risk Reward and Winrate. Normally you would think that your long-term profit/loss ratio would (naturally) drop to 50%, which represents you simply picking where the price has gone up or down since a certain point. With a 50% win rate, you can be profitable when your best risk reward is better than 1:1. Otherwise, in the long run, you will lose.
Reasonable risk reward rate
For a professional investor, the Risk Reward index plays a very important role. Risk Reward helps professional traders manage their risks scientifically and reap the most long-term benefits. And there really are no official statistics on the R:R ratio of professional investors. But one thing you can note, traders who make long-term, stable profits in the Forex market usually have a Risk Reward of at least 1:1, which is usually between 1:2 and 1:3.
The importance of risk reward
- In all trading systems, there is a need for a hedging strategy. The Risk – Reward ratio is a measure of the risk before placing an order. And it tells you what the potential profit of the next order is in relation to the risk taken.
- The risk-reward ratio helps you determine whether the quality of a trade is good or bad. Theoretically, if the risk-reward is better than 1, it is good for trading. Depending on the Winrate of each transaction, this ratio needs to be adjusted accordingly.
- A good risk-reward strategy allows you to be profitable in the long run, even if the analysis is only 50% correct or less.
Improve Risk Reward Rate in Forex Trading
Although each trading strategy sets a separate risk:reward ratio, in some cases you can still improve this ratio better.
- One of the most effective ways is to optimize entry points into your trading strategy.
- Optimizing the trading strategy: The trading strategy determines the Risk Reward ratio.
- Set Conditions for Risk Reward: Just add the minimum RR condition in your trading system.
If you choose a minimum RR of 1:1, both of the above strategies can be entered.
If you choose the minimum RR 1:2, you only enter the first strategy, ignore the second strategy, no matter how good you see the entry point.
- Discipline with taking profits and stop loss: During the entire trading process, you need to better control your trading psychology to have the desired profit
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Above is information about what the Risk Reward index is and the importance of the Risk Reward index for investors to have an effective trading strategy. To trade better with this R:R ratio, you need more real time to fight and learn more Forex signals for better probability of winning trades. Also, you can learn the Solution when your Forex account is on fire, please wait.
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