Forex: Setting Your Risk-Reward Level

Filed under: Learn Forex Trading |

One of the biggest decisions you will make when trading forex is deciding on your risk levels and your risk-reward scenarios. To begin with, let’s start with the basics.

 

If you risk 1% of your trading capital on each trade, and you target a 2% gain on your capital as your target, then we say that your risk-reward scenario is a ratio of 1:2. So if you risk $100 on a trade, and your target is to make a profit of $200, then this is an RR of 1:2. Similarly, if you risked 2% of your bank, or $200, on a trade, and your target was to gain $400, then this also is an RR of 1:2. Here are some more examples:

 

Risk 2.5% of bank, target 7.5% of bank = RR of 1:3

Risk 1% of bank, target 4% of bank = RR of 1:4

Risk 0.5% of bank, target 2.5% of bank = RR of 1:5

Risk 1% of bank, target 0.5% of bank = RR of 2:1

 

So why is this important? Well, if your potential reward is less than your risk, then you will have to have a very high winning percentage in order to be profitable. On the other hand, if you have a RR of 1:5, you will have a lot of losing trades, but you will only need a winning percentage of around 20% in order to pull a profit. What RR you choose will depend on a number of factors.

 

One of these factors is your personality. If you can’t handle losing trades, then you will need a high winning percentage and a lower RR. However, if you can take a more long-term approach and can handle long sequences of losers, then you can higher your RR. The other factor that you must consider is what the market is doing, and if there are any areas of support/resistance that might challenge your profit target area.

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