Download!Download Point responsive WP Theme for FREE!

The Importance Of Risk Reward Ratios

Trading statistics can be quite alarming. Every now and then the statistic of how many winning traders there are out there resurfaces and at first sight is quite alarming.

 

Around 70% of traders will consistently lose money. How do we know this? Each quarter US forex brokers must reveal the number of winning account and the number of losing accounts that they have. Each quarter, time and time again the statistics are approximately the same.

 

Around 705 of account are losing account, whilst approximately 30% are winners.

So, the statistic is fact, we know that. But the other interesting side to the statistics is the percentage of winning trades. A US forex broker carried out an in-depth study into the percentage of winning trades for particularly currency pairs. For the EUR/USD, the most traded currency pair in the world, the findings showed that 60% of trades that went through on this pair were winning trades. So 6 in every 10 trades was a winning trade, whilst 4 in every 10 was a losing trade.

 

Imagine each winning trade won $100, 6 x $100 = $600

Imagine each losing trade lost $100, 4 x $100 = $400

 

If this was the case the account would be a healthy profitable account.

 

However, what happens is that traders are willing to accept much less profit than they are willing to accept loss. In the case of the EUR/USD in this particular study, traders were willing to accept on average around 60 points in profit, whereas they were happy to accept over 125 points as a loss.

 

To put it more simply, traders were willing to accept twice as much risk for half as much gain. If you are willing to risk $200 to win $100 your account will slowly drain away. There is little chance of the account turning a profit. The trader would need to place a winning trade twice as often as they place a losing trade in order to just break even. That’s one reason why the traders need to do some research on their risks and opportunities in advance. Once a trader checks out the pitfalls, he’s more likely to score on the opportunities that come his way. 

How to avoid draining your account?

Using the risk reward ratio helps you focus your trading. You must define a stop loss and a target price before comparing the potential win to the potential loss and deciding if the trade is worthwhile. If you are looking at a trade where the profit is less than double the risk, step away.

Remember don’t arbitrary place the stop and the limit. Use the market structure.

 

Vantage FX provides its client with a superb charting package, or an MT4 or MT5 account are the industry standard for forex trading. Using these charts to identify where the market indicates the stop & limit should go then use these figures for the risk reward ratio. Include in your trading plan the circumstances under which you will accept the trade. Do not ever say I want $5 loss and $20 win and the place the orders accordingly as this method is almost guaranteed to end in failure.