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    Thread: Using risk:reward, what is the best number and how do we find it?

    1. #1
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      Default Using risk:reward, what is the best number and how do we find it?

      The question is about risk:reward, known as rr in short. This refers to how much we stand to lose or how much we stand to gain on a position. Some people say that they like to use rr 1:2 and some like 1:4, but how do we actually know which number is the best to use? How do we find out the best number? Is it even possible to know?

      Answering this question, and i do know a very good answer, requires extensive knowledge of both trading and mathematics. Several concepts need to be understood to explain this. Use them all here. My challenge is for you to best describe and answer this completely. This is no simple task, remember that.



      Note: The question is already fully explored with many answer.
      http://forum.mt5.com/showthread.php?...1#post12757435
      Last edited by PhantomTrader79; 05-13-2018 at 07:29 AM.

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      All about Risk Reward Ratio

      Definition: A Risk Reward ratio tells us about how much is your attainable reward for every dollar you risk.

      For Example: a RR ratio of 1:2 means that you are risking $1 to make $2.

      But a good Risk Reward Ratio like 1:2 or above don't tell us the whole story and most of the time it misleads us. While it's normal to target a good RR ratio but we have to go more deep to understand why it is deceptive.

      Let's say a trader wants a RR ratio of 1:2

      But his trading system allows him to win 30%

      So out of 10 trade 3 becomes winner and 7 ends up as losers.

      Now it's simple calculation

      Total Gain= 3*2= 6$
      Total Loss= 7*1= -7$

      Net Loss= -1$


      So even though your Reward was double than the money you were risking still your account is going down. That's why it became useless.

      We have to make sure that our winning percentage is at least 50% and this will help us to succeed in the long term and grow our account. Only a RR ratio doesn't tell us the big picture of trading.So Instead of looking for the best RR we need to improve on our frequency of winners so that it can take care of the Risk Reward Ratio and most importantly grow our account.
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      Risk:Reward

      A question that has been going on for ages where every traders seem to have a different opinion about how it should be. Here is my take on it:

      Risk:reward ratio is simply the ratio between the amount you risk and the amount you chance to gain in your trade. Whether you risk 3% of your account to look to gain 5% or whether you risk 50% of your account to gain just 5%; that all comes under the risk:reward ratio.

      The R:R ratio seems simple and easily comprehended by the traders, but you can't just calculate it randomly and use it on your trade. Random R:R ratio is just pure foolishness and will in no way work for most of the times.
      Like using 1:4 r:r ratio for a trade which might not even give you twice your risk amount.

      Here is one example with 1:1.7 R:R reward ratio.
      Name:  GBPUSDH112.11.png
Views: 116
Size:  20.9 KB
      The trade was entered with the simple strategy of targeting the support area.

      The tp was touched and trade closed:
      Name:  GBPUSDH1 12.11 (2).png
Views: 119
Size:  35.9 KB

      I gained about 25 pips by risking about 17 pips (with spread) i.e with the calculation of lot size and in terms of my capital, I gained 5% of my capital by risking about 3%.

      Had the risk been beyond that, the trade wouldn't have been worth it. And trying to increase my reward ratio would mean using higher risk, 'cause I didn't see high probability of the trade going beyond the support area immediately.

      Considering the win rate of your strategy is also one way to determine R:R ratio, but even if your win rate is low, if the r:r ratio is good enough, you could make good profits in the long term. Of course, having a good win rate seems to be a must for most of the traders as they usually concentrate only on short term instead of long term.

      Overall, a proper risk:reward ratio takes in consideration your capital, your strategy, your experience and the market condition. Don't set your mind on what you have to do, be flexible in your decisions as you might miss out on great opportunities just because you were determined to use a fixed risk:reward ratio.


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      Indeed the use of risk reward ratio presents a very excellent answer as regards to enabling a trader to secure their trades from incessant risks that is a part of it that can come at any time and this comes because Forex is a business, It either breaks even, brings losses or brings profits.
      For me,

      I choose 1 : 1 risk reward ratio for trading commodities or Forex pairs with low Volatility.

      I choose 1 : 1.5 risk reward ratio for trading commodities or Forex pairs with normal Volatility.

      I choose 1 : 2 risk reward ratio for trading commodities or Forex pairs that have high Volatility.



      Each Forex trader should choose their preferred risk reward ratios that can easily enable them to manage their risks and their trading very well.


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      Risk:Reward (RR)

      Risk:Reward (RR) is a kind of ratio that is widely used by some traders so traders will compare the expected result from balance account or capital held in trading account with the amount of risk taken to obtain the result. This ratio divides the potential loss trader if price moves in the opposite direction from the open position (Risk) with the potential profit to be received when the position is closed (Reward).

      For example:

      You want to trade multiple pairs using 0.1 lot with stop loss 40 pips and profit target 80 pips, your RR Ratio is 1:2 (40:80) so you are trading with twice the amount of your risk.
      Let's say you have trading strategy with winning rate 80% and you are using RR ratio 1:2 in every trading you do. In a month you make 20 trades then if calculated

      Possibility of winning 80% from 20 times trading:
      80% x 20
      (80 : 100) x 20 = 16 win
      20 - 16 = 4 loss

      (16 win x 80 pips) = 1280 x 0.1 lot = 128$
      (4 loss x 40 pips) = 160 x 0.1 lot = 16$

      At the end of the month you will get:
      128$ - 16$ = 112$

      RR ratio will vary for each trader based on trading strategy used in trading and market situation. Using RR ratio also required good money management to obtain satisfactory results.
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      Risk: Reward

      the fact that the forex trading business is a very risky one makes the concept of risk to reward a very crucial thing in the forex trading business. it is one area which the forex trader could exploit to advantage as he pursues his trading career or activities.

      the layman's definition of risk to reward is how much a trader is willing to lose to gain a certain amount of reward. in other words, the trader already made up his mind on the loss or profit amounts in respect of a particular trade.

      there is no particularly set standard, but it is generally accepted that the lower the risk the better. the expected reward should always supersede the loss. examples of good risk to reward ratio would be 1:3 or 1:4. however, to really arrive at the best risk to reward, the forex trader should check his win rate. a forex trader with a high win rate might set a risk to reward ratio 1:3 or 1:4. for example, if the win rate is 60%, then from every 10 trades, he wins 6 times. if he uses RR 1:2 or 10 pips:20 pips, then when he loses 4 times, he has 40 pips loss, while his 6 wins would give him 120 pips profit. overall, he has gained 80 pips!

      factoring in the spread now, the trader loses 40 pips + 12 pips{3 pips spreads on 4 trades} = 52 pips.
      120 pips - 18 pips{3 pips spreads on 6 trades =102 pips

      the trader's net profit would therefore be 102- 52 = 50 pips.

      the stop loss and the target profit points must be set to make risk to reward work best.
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      Suppose you have $ 10,000 in your account. Then you set the maximum risk for each transaction, say 5% per trade. This means that the maximum loss you might suffer from each transaction is 5% x $ 10,000 = $ 500. So, the risk for every transaction you make can not be more than $ 500.

      Should your first transaction suffer a loss, then your remaining funds are $ 9,500. Well, if you want to do another transaction with a 5% per trade risk limit, then the maximum risk for the next transaction is 5% x $ 9,500 = $ 475. And so on: 5% risk limitation is based on the last capital owned.

      In addition, you should also limit the maximum risk of your capital. For example, with the $ 10,000 you had to limit the risk by 50%, then you should stop trading or evaluate if you lose up to $ 5,000.


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      Using risk:reward, what is the best number and how do we find it?

      Concepts like Risk-to-Reward Ratio presuppose that financial markets can be modelled using linear models or gauged using linear measures. Unfortunately, this is not the case because financial markets such as the spot forex market are non-linear dynamical systems that can only be modelled using econometric concepts such as Markov Processes, Auto-Regressive Processes and other Stochastic Processes.

      To all intents and purposes, the Risk-to-Reward Ratio is a linear measure which only suits the application of linear thinking to the markets. This invariably leads to disastrous outcomes as the record of traders' performance shows time and time again. Classical trading advice recommends using a Risk-to-Reward Ratio of at least 1:1.5 (which implicitly employs linear thinking), but the real world of trading continually throws up scenarios where one can even go for a Risk-to-Reward Ratio of 1: 0.5 or less by making extensive use of growth formulas such as the Fibonacci Series/Golden Mean and Archimedean Spiral.

      There is no best number when thinking about Risk-to-Reward Ratios in financial assets trading: It is an illusion.


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      Default What is risk to reward ratio and how it impacts our profitability?

      When learning to trade we always hear others saying always make sure our risk to reward ratio are good so we can profit more. But what is actually risk to reward ratio and how does it impact our profitability in trading?


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