THE POWER OF RISK REWARD
There are a few ways one can double or triple your profits in Forex trading by applying some more advanced principles. One of them e.g. is scaling in and out of a good trend, but another powerful principle is using Risk : Reward to your advantage. E.g it is possible to have only 30% winning trades, but still be a profitable Forex trader, if you apply a Risk : Reward of 1 : 3.
Risk : Reward is measured by the ratio of your Risk (determined by the size of Stop Loss) to that of your Reward (determined by the size of Take Profit). E.g. if you have a 30 pip Stop Loss and a 60 pip Take Profit your Risk : Reward is equal to 1 : 2. It is therefore clear that it is very important that your skill to determine the best trades, which is in turn based on your skill of setting optimal Stop Losses and Take Profits, will help you to find the best Risk : Reward situations.
There are certain trading environments where good Risk : Reward situations can be found much easier based on the following trading approaches:
- Trading with the Trend and entering trades on the return of the price in direction of the trend after a correction / retracement and / or an unsuccessful attempt at breaking the trend line. Risk : Rewards of up to 1 : 3 is common in this environment.
- Doing Range trading or trading in a broad channel where the Stop Loss is just above / below the Resistsance / Support level. (1 : 3 possible)
- Trading Patterns where either the Resistance level or Support level or Both is sloping towards each other. Examples are wedges, pennants, triangles, etc. (Can use 1 : 2 in most cases)
- When trading the SR System it can be found with entries at the start of a new trend (reversal of old trend has been confirmed) or when a retracement in a strong trend is moving back into the direction of the trend. And, of course, where it combines with one of the other situations mentioned above.
The table below compares 5 different ways of increasing profits or the % growth of your account, and based on these figures we come to the following conclusions:
- The effect of increasing the capital that you trade with, or the percentage maximum risk you take, or the number of trades you take per month (based on the same statistical result) is directly proportional to the size of the increase. E.g. if you double your maximum percentage risk you will also double your profit and growth in direct proportion.
- But if you increase your percentage winning trades by 10% the effect on your profit and growth can be as high as 300% !
- And if I change my Risk : Reward from 1 : 1 to 1 : 2 my profit and growrh can be increased with so much as 400% !!
Study the table below to see what the effect of the different parameters have on profit and growth:
Capital | % Risk of Capital | Reward (Risk=1) | % Winning Trades | # of Trades / Month | Gross Profit / Month | Gross Loss / Month | Netto Profit / Month | % Growth / Month | |
1000 | 1 | 1 | 60 | 40 | 240 | 160 | 80 | 8 | |
1000 | 1 | 3 | 30 | 40 | 360 | 280 | 80 | 8 | |
1000 | 1 | 1 | 70 | 40 | 280 | 120 | 160 | 16 | |
5000 | 1 | 1 | 70 | 40 | 1400 | 600 | 800 | 16 | |
1000 | 1 | 2 | 50 | 40 | 400 | 200 | 200 | 20 | |
1000 | 1 | 3 | 40 | 40 | 480 | 240 | 240 | 24 | |
1000 | 1 | 1 | 80 | 40 | 320 | 80 | 240 | 24 | |
1000 | 1 | 1 | 70 | 80 | 560 | 240 | 320 | 32 | |
1000 | 2 | 1 | 70 | 40 | 560 | 240 | 320 | 32 | |
1000 | 1 | 2 | 60 | 40 | 480 | 160 | 320 | 32 | |
1000 | 1 | 3 | 50 | 40 | 600 | 200 | 400 | 40 | |
1000 | 1 | 2 | 70 | 40 | 560 | 120 | 440 | 44 | |
1000 | 1 | 3 | 60 | 40 | 720 | 160 | 560 | 56 | |
1000 | 1 | 3 | 70 | 40 | 840 | 120 | 720 | 72 | |
The Effect of Improving Winning Percentage | |||||||||
1000 | 1 | 1 | 60 | 40 | 240 | 160 | 80 | 8 | |
1000 | 1 | 1 | 70 | 40 | 280 | 120 | 160 | 16 | |
1000 | 1 | 1 | 80 | 40 | 320 | 80 | 240 | 24 | |
The Effect of Improving Risk : Reward | |||||||||
1000 | 1 | 1 | 60 | 40 | 240 | 160 | 80 | 8 | |
1000 | 1 | 2 | 60 | 40 | 480 | 160 | 320 | 32 | |
1000 | 1 | 3 | 60 | 40 | 720 | 160 | 560 | 56 |
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