How to find the best Risk and Reward ratio in FX

Professional trading is not like having a job with steady income or going to a gambling house. Professional trading is more like running a business. In trading, losing is a part of the process. The idea is to have a trading strategy that provides you with enough winning trades that cover the losses and grow your account balance.

There are two major things that can contribute to your trading strategy’s profitability in the long run: 

• Risk to Reward ratio
• Success rate

In general, traders avoid opening trades that have 1 risk and less than 1 reward ratio. For instance, if you find a trading setup that requires you to place Stop Loss 90 pips away and Take Profit target is 30 pips away, most professional traders will not take the trade. Experienced traders do not open 3 to 1 risk reward ratio positions. 

Usually, Forex traders take trades with 1:2, 1:3 risk to reward ratios or higher. However, it is also possible to make money even when your risk to reward ratio is just 1:1. 

How is that even possible? Well, as we’ve already mentioned, one more important aspect to take into account is the Success rate. For instance, if you trade a pattern that predicts future price direction accurately 9 times out of 10, you can use 1:1 risk to reward ratio and still grow your trading balance easily. 

Risk to reward ratio is also known as R/R in investing, and it plays an important role in risk management.

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Forex risk reward ratio strategy – how it works

That's the best risk to reward ratio Forex strategy? It's logical to say that the best strategy gives you crazy rewards and the smallest risks, right? — wrong. There's a lot to take into account before deciding on the best risk to reward ratio. For instance, let's say you are only trading setups that have 1 risk and 10 reward ratio. On paper 1:10 seems amazing, however, how often can you find trading setups that can give you such a ratio? What is the success rate of trading the setup? You might spend a whole year glued to your screen and never see a trading opportunity with 1:10 ratio. 

Consistently profitable traders care less about what will happen in any single trade. They care about what will happen after hundreds of trades. Risk to reward and success rate are both highly important in this regard. The main goal of trading is to make money after a series of trades. As we've already mentioned, RR and success rate are decisive in profitability. Let's discuss each in more detail:
 

Risk to Reward Ratio and success rate

Let's discuss two scenarios to better understand how to select risk to reward ratio for our trades:

Scenario 1: Let's say you are trading Doji or some other trading pattern that have 50% success rate, in other words, price can go in any direction. In order to make money trading this setup in the long run, your rewards need to be greater than risks. Keep in mind that there are also trading and non trading fees that need to be covered. Ideally, when success rate is 50%, risk to reward ratio should be 1:2 or greater.

Scenario 2: Let's say you are trading a trading setup that has 60% success rate. In other words, on average, 6 out of 10 trades close in profits. In this case, you can use 1:1 risk to reward ratio and still make money in the long run. 

How to spot risks and rewards

It's not recommended to open trading positions when you do not see a Stop Loss targets. However, this in not so obvious in the case of profits. Often, trading patterns give traders entry signals, well-defined stop loss targets but not clear profit targets. This is especially true for trend trading patterns and indicators. When you join a strong trend, would you exit whenever you reach the profit target, just because your risk to reward ratio says so? Of course not. A professional trader would ride a strong trend instead of simply exiting. It's justified to open some trades that do not show clear profit targets. In general, these setups give traders general expression and most patterns offer greater than 1:1 risk/reward ratios. 

Reasons to modify R/R targets after entering a trade

In general, it's not recommended to touch Stop Loss and Take Profit orders once they're placed. Once a trader opens a position, his/her psychology changes. Human emotions such as doubt, fear, greed, excitement, etc. become much more powerful and can overshadow the ability to clearly judge the situation.

However, there are cases where it's more beneficial to change the reward target. Traders that ride strong trends have tools and techniques that enable them to find exit points. Some use trailing stops that lock in profits. Others partially close their positions and exit gradually. Managing a successful trade is more difficult than a losing one, as it takes more precision and focus. 

When it comes to changing the Stop Loss target, it's highly dangerous and totally terrible idea. One of the main reasons why traders blow up their trading accounts is that they increase their risks while hoping the price will reverse. It's recommended to never touch your stop loss once in a trade. Or at least have clear reasons for it. 

Practical use of risk and reward ratio

It's hard to find the best risk to reward ratio in Forex. Ultimately, it all depends on the trading setup. Today you may find a setup with 1:2 ratio and tomorrow with 1:4. Decision-making becomes more complex when we are including success rate in our analysis. To make it simple, most traders avoid opening positions that have 1 risk and less than 1 reward ratios. In addition, traders also avoid trades with less than 50% success rate. In order to increase the success rate, traders are integrating various indicators and fundamental analysis tools. It's worth mentioning that the more tools and indicators you use to confirm a trade direction, the more precise the trade will be, however, over-usage of indicators can also have negative effects. Traders that take too many factors into consideration are experiencing analysis paralysis extremely often. Trading should be effortless and simple. 

Understand risk ratio in Forex, and it's effect on your results can improve your skills. Risks and rewards play a major role in risk management. To trade consistently profitably, it's important to trade setups that have the proper level of risk to reward ratio. In addition, it's critical to never take huge sized positions. Professional traders usually risk up to 1 to 5% of their trading capital per trade. When positions are oversized, profitability gets dependent on luck and not on probabilities. What's more, it's critical to note that risk management also involves managing traders' emotions. All of these aspects, when managed properly, produce amazing results.