While every successfultrader has his or herownway of being consistently profitable, there are afew “common denominators” that all profitabletraders follow without exception. Chad and Ihave a combined 17 years of experience in this market, with 8 of those years spent teaching others our forex trading strategies. As you might imagine we have met many traders along the way. As Chad and I discussed this forex training article series we thought of the different commondenominatorsall successful traders we know follow. In part 1 of this training series, we will break down risk/reward and discuss its importance if you are to ever profit from the forex market.
Why Is Risk/Reward Critical?
Forex trading by its very nature is a game of statistics and probabilities. Profitability is the combination of a win to loss ratio vs. the risk/reward of those trades taken. Simply put one can be profitable in ONLY two ways. First you can maintain a high winning percentage, or second, you can maintain a high risk/reward (R/R) ratio. What though is the common denominator between profitable traders? Without a doubt, the answer is risk vs. reward. Those who strive after a win/loss ratio of 80-90% almost always do so at the expense of the R/R ratio, and this is a dangerous trade-off.
The best way to illustrate the importance of R/R is to show a real-life example of it. Below is roughly a month and a half of Chad’s track record. Let’s break down the numbers…
Winning Trades – 18 (53%)
Losing Trades – 17 (47%)
Average Profit – $1,704
Average Loss – $606
Overall R/R – 2.8/1
Overall Profit – $20,414.33
Does this begin to make clear why R/R is so critical if you are to ever become a successful forex trader? Contrary to the lie many tell….most profitable forex traders win between 60-70% of their trades based on our experience over the years. Over the last month and a half Chad has managed a to turn a profit on 53% of his trades. Would you consider that track record a success?Without a doubt, the win/loss ratio is lower than both Chad and I usually average but this so perfectly illustrates the power of the bank trading strategy and its ability to present high R/R trade setups.
Breaking Down The Numbers…
While 4 standard lots is not a huge lot size, most reading this will be trading with an account that is smaller and thus is using smaller lots sizes per trade. To illustrate the power of R/R lets break down the numbers using an account size of $2,000. If you risk 2% per trade that would be $40 risk per trade you take. Thus if you keep the 2.8 to 1 R/R as shown above you would profit $112 on each winning trade. Let’s see how this breaks down using the number of trades in the track record above…
18 Winning Trades – $2016 (18 trades X $112 profit per trade)
17 Losing Trades – $680 (17 trades X $40 risk per trade)
Total Profit – $1336 or +66.8% gain
Using the R/R in the track record listed above you could win as little as 30% of the time and still make money! Hands down if your losing money in the forex market it is almost certainly because you have a poor R/R per trade. I strongly urge you to go back through your last 50-100 trades and determine your overall R/R ratio. How then does one increase their R/R properly?
High Risk/Reward Day Trading Strategies
At this point, I’m sure you can see the value and importance of maintaining a high R/R in your trading. At the heart of the track record listed above is the forex bank trading strategies. The concept is really quite simple. When the banks enter a trade they do not do so to make a 5, 10, or even 20 pip profit. As we have discussed before because they enter positions over time it takes larger moves in order to exit those accumulated positions. Because of this when a trader has truly identified a high probability bank trading setup the market is usually in for at least a 90 pip move.
Trade setups such as the stop run reversal for example, often allow for -20 pip stop losses….thus a 2 to 1 R/R on these day trades is normallyachievable. Additionally trading with the smart money trend generally gives high R/R setups. The key is understanding how the banks move the forex market and taking those high probability setups when at least a 2 to 1 R/R is probable. Doing so is the key to profits like those seen in above!
Sterling
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FAQs
There are two main risk factors that come with forex trading: volatility and margin. Let's examine what each is in turn, before we take a look at how to mitigate them.
What is the 5 3 1 forex strategy? ›
The 5-3-1 strategy is especially helpful for new traders who may be overwhelmed by the dozens of currency pairs available and the 24-7 nature of the market. The numbers five, three, and one stand for: Five currency pairs to learn and trade. Three strategies to become an expert on and use with your trades.
What is the 1 risk per trade? ›
The 1% risk rule means not risking more than 1% of account capital on a single trade. It doesn't mean only putting 1% of your capital into a trade. Put as much capital as you wish, but if the trade is losing more than 1% of your total capital, close the position.
What is 2% risk in forex? ›
One popular method is the 2% Rule, which means you never put more than 2% of your account equity at risk (Table 1). For example, if you are trading a $50,000 account, and you choose a risk management stop loss of 2%, you could risk up to $1,000 on any given trade.
Why 90% of forex traders lose money? ›
The reason many forex traders fail is that they are undercapitalized in relation to the size of the trades they make. It is either greed or the prospect of controlling vast amounts of money with only a small amount of capital that coerces forex traders to take on such huge and fragile financial risk.
How much do forex traders risk per trade? ›
Risk per trade should always be a small percentage of your total capital. A good starting percentage could be 2% of your available trading capital. So, for example, if you have $5000 in your account, the maximum loss allowable should be no more than 2%.
What is 90% rule in forex? ›
The 90 rule in Forex is a commonly cited statistic that states that 90% of Forex traders lose 90% of their money in the first 90 days. This is a sobering statistic, but it is important to understand why it is true and how to avoid falling into the same trap.
Is there a 100% forex strategy? ›
Trading forex is risky and complicated, and no strategy can guarantee consistent profits. Successful forex traders are those who tend to have a good understanding of the market, good risk management skills, and the ability to adapt to changing market conditions.
What is the 357 rule in trading? ›
What is the 3 5 7 rule in trading? A risk management principle known as the “3-5-7” rule in trading advises diversifying one's financial holdings to reduce risk. The 3% rule states that you should never risk more than 3% of your whole trading capital on a single deal.
What is the 1% rule of trading? ›
Enter the 1% rule, a risk management strategy that acts as a safety net, safeguarding your capital and fostering a disciplined approach to navigate the market's turbulent waters. In essence, the 1% rule dictates that you never risk more than 1% of your trading capital on a single trade.
A lot of day traders follow what's called the one-percent rule. Basically, this rule of thumb suggests that you should never put more than 1% of your capital or your trading account into a single trade. So if you have $10,000 in your trading account, your position in any given instrument shouldn't be more than $100.
What is the 1 rule in day trading? ›
The 1% rule for day traders limits the risk on any given trade to no more than 1% of a trader's total account value. Traders can risk 1% of their account by trading either large positions with tight stop-losses or small positions with stop-losses placed far away from the entry price.
What is the highest risk in forex trading? ›
Forex Risks - Common Risk Factors in Currency Markets
- Exchange Rate Risk.
- Interest Rate Risk.
- Credit Risk.
- Country Risk.
- Liquidity Risk.
- Marginal or Leverage Risk.
- Transactional Risk.
- Risk of Ruin.
Here's a general guideline for determining optimal leverage based on account size: Account Size: $10 - $50 Recommended Leverage: 1:100 or lower. Account Size: $100 - $200 Recommended Leverage: 1:200 or lower. Account Size: $200+ Recommended Leverage: 1:300 - 1:500 (for experienced traders)
Can I risk 10% per trade? ›
Lesson summary. Always calculate your maximum risk per trade: Generally, risking under 2% of your total trading capital per trade is considered sensible. Anything over 5% is usually considered high risk.
What is the highest risk trading? ›
While the product names and descriptions can often change, examples of high-risk investments include: Cryptoassets (also known as cryptos) Mini-bonds (sometimes called high interest return bonds) Land banking.
Why do 95 of forex traders fail? ›
Inadequate Risk Management: A common reason for failure is not managing risk effectively. This includes investing too much capital in one position, not setting stop-loss limits, or failing to diversify. Poor risk management can lead to substantial losses, especially in volatile markets.
What is the greatest risk associated with forex settlement? ›
Credit risk is often considered the greatest risk associated with Forex (foreign exchange) settlemen...
What is the biggest risk in trading? ›
There are three main categories of risk every trader is exposed to - market risk, liquidity risk and systemic risk.
