The risk reward ratio in forex or R/R ratio is the way to compare the potential profit of trade to its potential loss. It needs to be calculated to prevent hazardous loss in trading. It is required to know before:
- Potential profit- It is the price difference between the profit target and the entry cost or price.
- Stop loss order- It is the order to sell automatically in case the security value of trade dips down to the desired amount. It helps prevent the loss to a certain extent before the trade value drops to a lower amount.
The calculation can be done by dividing the difference between the entry point of a trade and the stop loss order of risk by the difference between the profit target or goal and the entry point of the reward.
Risk can be calculated through the stop loss order that is by finding out the difference between the entry point of a trade and the stop loss order. It’s important to set an exit point for the trade to move in favor of the profit target.
Is the Calculation of the Risk/Reward Ratio Important?
Yes, it is the answer to the question in common why do so many traders lose money in trading after a huge analysis of the market and having the position of winning rate of their trades?
It happens due to the misconception of Forex trading with money management. Here, the R/R ratio is important to get calculated. Many of the traders experience an array of losing trades in beginning due to this.
It’s better not to ignore the basic need for reward to ratios of the trades to save one from a major loss.
How Can the Risk Reward Ratio in Forex Calculate?
Reward to the risk ratio of trade is its potential profit divided by the potential loss. To calculate the R/R ratio in forex, you have to think about the above-mentioned process, which is to divide the entry-level price and the stop level price(risk) by the difference between the profit target and the entry-level price(reward).
Remember in case the reward is greater than the risk like 1:3, the ratio is less than 1 whereas if the risk is greater than the reward like 4:1, the ratio is greater than 1.
Use the formula for the risk reward ratio to calculate the forex trade.
Risk reward ratio=Entry price value –stop loss value/Entry price value-target price value
But still, there is confusion in getting the right decision of take-profit and stop-loss levels for the desired trade. Again the question comes, what R/R ratio can be good enough to take a trade that has a fine technical setup?
The Process to Set up the Mind for the Same
- Find the best place for stop loss –Always carefully decide the best level to place your stop loss order. Remember all four types of stop loss orders:
- Equity stops
- Volatile stops
- Time stops
- Chart stops
Use all types of stop loss orders depending on the trading strategy but chart stops are most efficient as it is based on the significant technical levels placed on the chart.
- Decide the profit target- After deciding the best place to stop loss, you can do the proper analysis through the chart to set the best profit target for your trade. The technical levels-based charts help return the best result for the profit target. For example- In case the stop loss is 100 pips, check for the profit target of a minimum of 100 pips away from the entry-level price to ensure the R/R ratio is 1 at least.
- Divide the potential profit with potential loss- After getting the potential take-profit and the stop loss levels, divide them as per the formula to get the final R/R ratio for your forex trade.
Hope the above-mentioned information will help you to set your profit targets with a lower risk included during forex trading. Now you know how to calculate the risk reward ratio in forex.
Only a low-risk reward ratio will not reveal all the required information regarding the trade but need to know the limitations to reach the desired profit targets. The best way to solve the problem is to select the best R/R ratio to balance the need of taking trades that can give maximum profit in comparison to risk. But ensure the chance of the trade to reach the target before stopping loss.
To make full use of the R/R ratio, the trade plan needs to be revised to have the acceptable market conditions, points to know when and where to enter a trade, and placing of stop-loss with profit targets as per the set market conditions.
Except for the R/R ratio, need to look into the other aspects to manage risk factors for better profit levels like win/loss ratio and break-even percentage. The win/loss ratio makes you alert for trading by comparing the number of winning trades with the losing ones. The break-even percentage provides you with the number of winning trades that are required to break even.