MoneyTec Traders Community Forum - View Single Post - Why we are taught to set risk/reward ratio larger than 1

mishak · 20-10-2003, 23:09

Risking $1000 to Get ... Part 1/6

This is the part of answers to questions posed here by overload

Many of us have learned that we should trade with risk/reward ratio 1:3 or 1:2 or at least 1:1.5
This money management rule means that before taking a position on the market (forex or stocks etc.) we should analysize what kind of profit (reward) we are expecting to achieve and compare it to the amount of money we are ready to lose (risk).

For example, say EUR/USD rate is 1.1600 and we wish to buy because we expect the Euro will go up to 1.1675 - this is our target.
If however we are unlucky and the Euro will go down, we are ready to recognize our failure when the price reaches 1.1575.
In this example our reward is 75 pips and risk is 25 pips. So, we are trading with risk/reward ration 1:3.
(btw, we should set T/P (take profit) order at 1.1675 and S/L (stop loss) order at 1.1575 in this example).

Why we are taught to set risk/reward ratio larger than 1
Because when we (unexperienced at that time) started to trade forex, most of us had the slightest idea where the EUR/USD will go from 1.1600. And we were at the same position after the first, second, third (you name it) deal.
Our instructor had expected this. And he wished that we stayed in the market longer to get our experience (or to pay him more monthly fees, or spreads - please no offence intended).

So, he told us:
if you trade with risk/reward ratio 1:3, you can afford to lose three deals of every four and still break even.
Look, say you lose three times of 25 pips for -75 pips summary loss . However when you'll win your fourth deal for +75 pips , you still keep all your money -75+75=0.

Then he continued:
if you perform better, say lose two deals of every three, then you will make profits.
Look, say you lose two times of 25 pips for summary -50 loss, than win the third one +75. Your total balance is -50+75= +25 pips - good profit

When you get experienced, you may drop risk/reward ratio to 1:1,5. In this case you can still lose 3 deals of 5 (60%) and break even !
Anyhow, please keep risk/reward above 1.

Was he right ?

20-10-2003, 23:09	#1
mishak old hand Join Date: Oct 2003 Posts: 1,066 Downloads: 0 Uploads: 0 Rep Power: 0	Why we are taught to set risk/reward ratio larger than 1 Risking $1000 to Get ... Part 1/6 This is the part of answers to questions posed here by overload Many of us have learned that we should trade with risk/reward ratio 1:3 or 1:2 or at least 1:1.5 This money management rule means that before taking a position on the market (forex or stocks etc.) we should analysize what kind of profit (reward) we are expecting to achieve and compare it to the amount of money we are ready to lose (risk). For example, say EUR/USD rate is 1.1600 and we wish to buy because we expect the Euro will go up to 1.1675 - this is our target. If however we are unlucky and the Euro will go down, we are ready to recognize our failure when the price reaches 1.1575. In this example our reward is 75 pips and risk is 25 pips. So, we are trading with risk/reward ration 1:3. (btw, we should set T/P (take profit) order at 1.1675 and S/L (stop loss) order at 1.1575 in this example). Why we are taught to set risk/reward ratio larger than 1 Because when we (unexperienced at that time) started to trade forex, most of us had the slightest idea where the EUR/USD will go from 1.1600. And we were at the same position after the first, second, third (you name it) deal. Our instructor had expected this. And he wished that we stayed in the market longer to get our experience (or to pay him more monthly fees, or spreads - please no offence intended). So, he told us: if you trade with risk/reward ratio 1:3, you can afford to lose three deals of every four and still break even. Look, say you lose three times of 25 pips for -75 pips summary loss . However when you'll win your fourth deal for +75 pips , you still keep all your money -75+75=0. Then he continued: if you perform better, say lose two deals of every three, then you will make profits. Look, say you lose two times of 25 pips for summary -50 loss, than win the third one +75. Your total balance is -50+75= +25 pips - good profit When you get experienced, you may drop risk/reward ratio to 1:1,5. In this case you can still lose 3 deals of 5 (60%) and break even ! Anyhow, please keep risk/reward above 1. Was he right ? some people doubt to be continued ... here ©MK 2003 What do you think ? Please add you comments Last edited by mishak : 23-10-2003 at 02:21.