Most novice traders think that to constantly make money in the market you must have a trading strategy that produces winning trades all the time but that isn’t true.
In fact, most professional traders make money on only 30-40% of their trade. Most traders have more losing trades. That’s a fact!
I also have more losing trades than wins.
To put this in perspective. Out of 10 trades I place , 6 of them are losses , only 4 wins…however my trading account keeps on growing. How is that possible? Well, you are about to find out!
Here, i want to show you something that most novice traders are not aware of. Something called risk/reward ratio.
WHAT IS RISK/REWARD RATIO?
Risk/reward ratio is about how much you risk per trade versus how much you can make in profit if you are right.
For example, if you risk $200 to make $800 then your risk:reward ratio would be 1:4. You risk $200 to make 800 return.
Let’s assume you have $10,000 account and you decide to risk only 2% per trade you take, meaning you risk $200 per trade.
For the sake of this example,Let’s say you have a risk/reward ratio of 1:4 (for every dollar you risk, you stand a chance to make $4) but your winning rate is 40%.
So, out of 10 trades, you have 6 losing trades and 4 winners..
Let’s do the maths and see how much you will make/lose after 10 trades…
- You place your 1st trade and it goes again you, you lose $200.
- 2nd trade, It hit your stop loss and you’re out with another loss of $200 loss
- 3rd trade, it goes as anticipated and you make $800 profit.
- 4th trade, .another Lose of $200.
- 5th trade, you make a profit $800
- 6th trade makes you another profit of $800
- You now place you 7th trade, you lose $200
- 8th trade, lose $200
- 9. Lose again $200
- 10th trade, you Make $800
You took 10 trades: 6 were losing trades and 4 were winning trades.
This means your percentage win ratio is 4/10 or 40%.
Now, let’s look at how much you are left with in your terminal:
Total Loss = $200×6 = $1,200
Total Gain = $800×4 = $3,300
Net gain = $3 200 -$ 1 200 = $ 2000
In this example, you can see that even if you only won 40% of your trades, you would still make a profit of $2,000. Just remember that whenever you trade with a good risk/reward ratio, your chances of being profitable are much greater even if you have a lower win percentage.
Now, imagine how much you could make in a long run as your account keeps on growing. Let’s say after few months you are able to double your account to $20, 000 and decide to risk 2% of $20 000 meaning you now risking $400 per trade. few years down the line you will be making a killing.
In this example, you can see that even if you only won 40% of your trades, you would still make money.this proves that you don’t really need to to be right most of the time to make money.
Risk reward ration is a very good approach. A trader can be wrong 10 times in a row and cover all the losses in 1 or two trades.
“It’s not whether you’re right or wrong that is important, but how much you make when you’re right and how much you lose when you’re wrong -George soros
I’ve included one live example (before and after) of a short trade I took few months ago on NZD/JPY before I wrote this post to show you the beauty of risk:reward ratio
I was anticipating a down move from 83.685 to 73.904 meaning I was expecting to make +900 pips should the price go my way.
Let’s see what happened after…
As you can see, the price went as i expected. however, I was stopped out with only +610 pips.
Here is the interesting thing though about this position:
when I entered this trade I placed a 30 pips stop loss so this means I risked 30 pips to make 600 pips meaning my risk:reward ratio was 1:20.3
-this is possible if you’re disciplined enough to use position sizing all the time and Learn to let your winners run and cut your losses short.
By now I hope you understand the risk/reward ratio
Subscribe to my newsletters!
To receive free weekly trading signals, trading tips, & strategies subscriber via email
talk to me
I am always interested to read your comments- talk to me in the comments below!
Also, don’t forget to share with your friends and family.