One of the first things we learnt as traders was the importance of paper trading and learning how to set your risk reward ratios properly. This is one of the most basic of trading principles that need to be learnt the right way from the first trade your ever make.
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For those of you reading this and have traded before, don’t fret, you are now able to learn the right way to set your Stop loss and take profit orders using a traditional risk reward ratio model.
When you open a trade, you should really have worked out how far you believe the market will go in your favor, and already have a conviction as to what the actual number will be. Once you have this number in mind it’s a simple, easy and quick process to get your S/L and T/P order set.
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The traditional formula for risk reward ratios in currency trading is 3:1 for beginner traders, for more experienced traders this number can increase to a minimum of 4:1 and in most cases will remain above 5:1. NEVER use risk reward ratios of less than 3:1 as the trade then becomes too risky.
Figure out the distance of the current market price to your target price (in pips). Once you have this number write it down.
Now take the total number of pips from the current market value and divide this number by the reward value to work out the risk ratio.
Now that you know the risk reward values, go ahead and calculate the distance from the current market price (in pip value) for both the risk and reward value and set these two numbers as your Stop Loss and Take Profit levels.
Lets say that the current price for AUDUSD is trading at 1.02659.
Lets presume the market will be bullish, and we would like to go long. Moreover, we also presume that the market will go to 1.02759 at a minimum.
So doing the math we take our target price of 1.02759 and subtract the current market price of 1.02659:
1.02759 - 1.02659 = 100 (pips)
Now that we know the target price is 100pips away from the current price and lets say we choose to work off a 3:1 risk reward ratio, lets continue the equation further:
To calculate the value in pips of the risk factor based on a 3:1 risk reward ratio we divide the total number of pips (reward) by the reward ratio:
100(pips) / 3(reward) = 33.33 (pips/ risk)
We now know both the risk reward value, all that’s left is for us to put a stop loss and take profit order with the corresponding values.
To calculate the last step, we take the current market price and subtract the risk value and add the reward value to the current market price, which will be your S/L, and T/P orders which in the above case are as below:
Please note when calculating the values as below, you need to keep it in the same format as the spread- if your value is 33 pips it needs to be added as the numerical decimal placement as the spread.
1.02659 – 0.00033 = 1.02626 S/L
1.02659 + 0.00100 = 1.02759 T/P
If you would like more information about risk reward ratios or need assistance with the calculating of the formula please let us know.
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