Risk is a part of trading. Every trade carries a certain level of risk. Every trader must know the amount of risk that is being assumed on each trade. Knowing the amount of risk on each trade is one way to limit it and to protect your trading account. The best way to know your risk is to determine the risk-reward ratio. It is one of the most effective risk management tools used in trading.
The risk-reward ratio is a parameter that helps a trader to determine the level of risk in a trade. It shows how much a trader is risking versus the potential reward (or profit) on a trade. While this may seem simplistic, many traders neglect taking this step and often find that their losses are very large.
The minimum risk vs reward ratio for a good forex system should be 1:2, however a larger ratio is always better.
How to determine the risk vs reward ratio?
<!–[if !supportLists]–>1. <!–[endif]–>Determine the amount of risk for the trade. This is equal to your entry price minus your stop loss price or potential exit price.
<!–[if !supportLists]–>2. <!–[endif]–>Determine the potential reward on the trade. Based on your analysis or system, the potential exit price minus your entry price is your reward.
The psychology of the trader plays a very important role in his trading decisions and style. The best traders keep their sentiments (greed and fear) out of their analysis and decide to trade with clear mind. Follow the advices below and you will notice a great deal of improvement in your trading style.