I remember when I used to give private lessons about Forex trading and most of them always started approaching me like: “do you lose trades sometimes?”, “How long is your current winning streak?”.
How many times you need to be right to be a profitable Forex trader? 70%? 80%? Most beginners think that in any case it should be a number that is higher than 50%.
What if I tell you that you can be profitable being right only 30% of times?
Yes, it is possible and we are going to see how.
Usually when new traders open a position, they tend to set their take profit at the same distance of their stop loss.
In this case they are risking exactly the same amount of their potential reward, so we say that the risk-to-reward is 1-to-1, that means that you are risking 1 dollar for every dollar that you can potentially get as a profit.
In this scenario, you need to be right more than 50% of times to be a profitable trader, because when you lose, you lose 1, when you win, you win 1.
Nothing to say about this strategy of money management, it can certainly fit the trading strategy and be profitable in the long run.
What if we move our risk to reward to 1:2? This means that your take profit is twice your stop loss. Do we still need to be profitable 50% of times? Let’s see what happens if we are right only 40% of times.
As you can see, with a risk reward of 1-to-2, you can be right only 40% of times and still be a profitable trader.
What happens if we push this concept even further and try with a risk reward of 1-to-3? Let’s see if we can be profitable if we are right only 30% of times.
With a risk reward of 1-to-3 we can be profitable even with a 30% winning ratio.
Of course when you are using a risk reward of 1:3, your chances to win the trade are lower, because you need to get an amount of pips that is 3 times bigger than what you are risking, but don’t forget one of the principles of Dow’s theory: price moves in trends. So if you are right and the price moves in a favorable direction, this kind of risk reward can be the best to maximize your profits or to limit your losses when you are wrong.
“Well, nice words Federico, but saying is one thing, doing is another”.
This is a Forex account of an institutional that has published the results for 10 years.
He used to apply a 1:3 risk-to-reward ratio, he had a profit of about 5.4M, although he lost 363 out of 656 trades (which is about 55% of losing trades).
Risk-reward ratio is a very important part of your Forex strategy, so I advise to try different ratios while you are still trading with your demo account, so you will realize which one suits you better.
In any case, don’t go under the 1-to-1 risk to reward. Never ever risk more than your potential profit.