Risk Reward and Profit Taking: Revisited

Filed under: Learn Forex Trading |

The concepts of risk-reward and profit taking are topics that I have discussed many times, but they are such core, key concepts in forex trading that they deserved to be discussed in more detail.

 

Risk-reward is all about how much you risk for getting a certain reward. If you risk 100 GBP for a potential profit of 100 GBP, then you risk-reward is 1:1. If you risk 100 GBP for a potential profit of 200 GBP, then you risk-reward is 1:2. However, changing your risk reward affects your winning percentage, and the tricky thing is, that we all have different psychological thresholds when it comes to losing.

 

Figure 1.

Figure 1 shows some possible outcomes when you change your risk-reward scenario (although these will change depending on you method of trading and your skill). As you can see, if you set your risk reward level too low or two high, then you could be heading for trouble. I find that a risk-reward of 1:2 or 1:3 is a sweet spot for myself, as this is the scenario that brings the most long term profits while also reducing drawdowns and making the winning percentage high enough to be tolerable.

 

The issue of profit taking is also another major issue and conundrum. I think what is important is to make a decision and stick to it long enough for you to draw some firm conclusions. What is not useful is to constantly chop and change your system, and not really know what you should be doing.

 

The problem with taking profits manually is that is it inextricably intertwined with your emotions, so if you can, you should even do your profit taking in a set and forget type manner. You can do this by splitting your trade into two or even three trades, and letting them all run to the desired target or stop loss.


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