Utilizing risk-to-reward ratio’s in forex is a popular and easy way to determine profit targets (exiting the trade).
The first step is to calculate the total risk involved in the trade as follows:
I. For buy trades
entry level – (stop loss level – spread)
II. For short trades
(stop loss level + spread) – entry level
Let’s assume the following examples:
Currency Pair: EUR/USD
Trade Direction: Buy
Entry Level: 1.2500
Stop Loss: 1.2450
Spread: 1 pip
Total risk: 1.2500 – (1.2450 – 1) =
Currency Pair: GBP/USD
Trade Direction: Short
Entry Level: 1.5530
Stop Loss: 1.5600
Spread: 3 pips
Total risk: (1.5600 + 3) – 1.5530 =
The second step is to calculate profit targets to exit the trade using risk-to-reward ratio’s.
Most common used risk-to-reward (RTR) ratio’s among traders are: 1:1, 1:2 and 1:3.
If you risk 100 pips to gain 100 pips ==> risk-to-reward would be 1:1
If you risk 100 pips to gain 200 pips ==> risk-to-reward would be 1:2
If you risk 100 pips to gain 300 pips ==> risk-to-reward would be 1:3
What’s the best risk-to-reward ratio used in forex?
It depends on the trader but the larger the better. A good RTR ratio would be at least 1:2. (for example, risking 100 pips to gain 200)
Additional: Forex Robots and risk-to-reward
Automated robots usually utilize awful risk-to-reward ratio’s. The vast majority of them risk at least 150 pips to make a 10 pip profit, that’s a 15:1 risk-to-reward ratio!