Why Does Risk Reward Ratio Matter so Much in Forex Trading?

Risk management is one of the factors that make a difference between professional and ordinary traders, but even among people who follow some rules, things are no well-understood. Most of the traders think about the “2% risk per trade” rule when they hear about risk management, but the reality is that they should focus on three main variables: percentage of account at risk per trade, trade accuracy, and risk-reward ratio. The last one will be our main topic for today, so if you want to take your trading to the next level, keep reading.

The nature of trading

For most of the beginners it’s hard to understand, but it will be impossible, no matter of the level of knowledge you reach, to eliminate losing trades from your trading process. Losses are part of the game and instead of trying to eliminate them,  you should learn to deal with them in a professional manner. The best brokers provide forex learning resources but few of them cover the importance of risk management. If you want to take your trading to the next level, you must learn more about how to manage risk.

How does risk-reward help you?

We assume that you already know planning is part of forex trading and before you enter the market, you know how much are you willing to risk per trade, and what will be your potential target, where you think the market could start to move in the opposite direction.

The ratio between how much you risk (usually in percentage points, or in pips) and the profit you make represents one of the three pillars of risk management for a simple reason. Let’s say over the next 10 trades, you’ll use a 50 pips stop loss and a 100 points take profit. If your accuracy will be 50% (which is usual among beginners) it means you’ll lose 250 pips and make 500 pips.

Even though half of your trades were negative, your overall performance over 10 trades will be +250 pips. Because the risk-reward ration can get you out of trouble when you encounter losses, it is imperative that you already aim to have targets at least twice as large as your stop losses. If you want to leverage your winners to the maximum, then this is how you do it. Even though our biology will push us to take profits sooner, you must learn to control yourself and think that the numbers will work against you, otherwise.