Search for the optimal «risk-profit» ratio
Almost all professional Forex clients in the Republic of Belarus use the profit-risk ratio to compare potential gains from trading positions with possible losses. The most popular parameters of this coefficient are the following numbers: 2:1, 3:1, 4:1 and they depend on many aspects, including the trading system, as well as the psychological stability of the client. Of course, the performance of transactions with non-deliverable financial instruments is influenced not only by this ratio, but also by other factors: managing the size of positions, market volatility, etc., but nevertheless, the ratio of profit and risk plays an important role in the development of the client as a professional.
Example of using the «profit-risk» ratio
Let’s say you decide to open purchase for ABC shares that are currently trading at $20 apiece. You buy 100 shares, which is equivalent to the position size of $ 2,000. The order to fix the price of the underlying asset, you put the take profit at $30, and the stop loss at $15 per share. In other words, you are willing to risk five dollars per share in the hope of earning $10 per share after closing your position. This is the 2:1 ratio. If your potential earnings were $15 per share, you could talk about a 3:1 ratio and so on.
At the same time, it is important to remember that a good profit-risk ratio does not give you any additional probability of success of the transaction, rather it is a technical point of trading.
The importance of the «risk-profit» ratio
Most clients tend to set the ratio between orders to fix the price of the underlying asset Stop Loss and Take Profit no worse than 1:1 because otherwise, we can talk about transactions with non-deliverable financial instruments with a high degree of risk. A positive ratio, such as 2:1, guarantees that your potential income will be higher than your potential losses in any case. And even if you get a loss on one of the positions, you will only need one good trade to return some of the margin collateral and get a net profit.
Below you will see a table where there are various options for the ratio of profit and risk, and also calculated the impact of these coefficients on the result of transactions with no-deliverable financial instruments.
We took 10 conditional trades, of which 5 are closed with a profit, and 5-with a loss. The unit in the ratio is equal to $100 (that is, the 2:1 entry indicates that we want to earn$200 with a risk of $ 100).
|Profit: risk||Probability of winning||Total profit||Total loss||Total return|
From the results of the table, you can clearly see the potential advantages that a high profit-risk ratio has. Even if you reduce the probability of winning trades to 40% or even 35%, in the last two ratios, you will still make a profit in the long run.