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ForEx Risk Management: The Importance of Reward-Risk Ratios
I have been trading currencies for about more than a year now. And I have an 80% winning ratio over losses. However, I still end up losing my account. Now, I have learned the use of reward:risk ratios and this has helped me very well in trading.
The concept of reward:risk ratios is that you the ratio should at least be 1 or more than 1. For example, if you are risking 250 pips loss on one trade. You should know that you can win by at least 250 pips on the other side. The best trades should be made when you have more than 2:1 reward:risk ratio.
As I am writing this hub, I always have a reward risk ratio of 400 pips:250 pips. This means that if I lose on a given trade (with a 0.01 lot size), I will only lose $2.5 of my capital. Provided that I am using an exchange account. However, if I win, I will win about $4. Since I have an 80% winning ratio (as evaluate by my past trades), I will win on the long run.
Before I opened a trade, I evaluated how much I am able to win through support and resistance and price points previously touched by the currency pair. If I know that I can get more than 250 pips win, then I will take the trade. However, if I will win less than 250 pips, then I will not take the trade. It's as simple as that. I will go to another currency pair or I will wait for that currency pair to rally (during downtrends) or to dip (during uptrends).
As you can see, simple risk management is what we need in order to trade. Your risk management ratio can also be due to percentages. For example, you will close a losing trade if you have a 2% loss and you will close a winning trade if you have an 8% win. This is the concept actually used by my friend (a Financial Analyst in an investment firm). It's simple math and all we have to do is to have the discipline to follow it.