Risk/profit ratio in trading
For example, Trader 1 has 75% of all positive trades, and Trader 2 has only 40% of all profitable trades. Which trader is more successful? Of course, we cannot answer this question because we do not know how much each trader earns on all profitable trades and how much they lose on all unprofitable ones. So the percentage (number) of profitable trades is not the most important factor of success in trading. Of course, each of us wants most of our trades to be profitable, but if we want to achieve real success in trading, we need to consider a different ratio.
This ratio is called "risk/profit" and this ratio is one of the most important aspects in money management, as well as a key factor in profitability in trading. Let's look at some examples:
- If you risk 100 points and want to earn 300, your the risk/profit ratio will be 1/3In other words, we risk 1 point for the sake of 3 points profit.
- If you risk 100 points and want to earn 200, your the risk/profit ratio will be 1/2In other words, we risk 1 point for the sake of 2 points of profit.
- If you risk 100 points and want to earn 100, your the risk/profit ratio will be 1/1In other words, we risk 1 point for 1 point of profit.
- If you risk 100 points and want to earn 50, your the risk/profit ratio will be 2/1In other words, we risk 2 points for the sake of 1 point of profit.
- If you risk 100 points and want to earn 25, your the risk/profit ratio will be 4/1In other words, we risk 4 points for the sake of 1 point of profit.
So, trader 1 will not have a profit, using the ratio 4/1 at 75% of all positive trades. On the other hand, trader 2 using a ratio of 1/2 at 40% of all positive trades - will have a profit.
It can be assumed that it is 1/2 ratio is beneficial. If you open a trade with a risk of 25 pips, it is necessary to set Take Profit at the 50-point level.
Also, try to move the stop loss closer to the opening order when the price reaches + 25 pips, i.e. half way in your favor. For example, you bought at 1.2500 and set a stop loss at 1.2475, your risk is 25 pips.
Using the 1/2 ratio means that Take Profit should now be set at the level of 1.2550, that is 50 pips profit. When the price rises to the level of 1.2525 you need to move the stop loss to the level of the order opening, that is 1.2500. In this case, you, or will fix profit, or will lose nothing. Already after you have established a stop loss on level of opening of the order, you can look for other points of an entrance.