Money Management Coaching: 3. What is Risk to Reward Ratio?

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What is Risk to Reward Ratio?

 

A ratio used by many investors to compare the expected returns of an investment to the amount of risk undertaken to capture these returns.

Example: If you bought EUR/USD:

BUY EU @ 140.00, SL 139.70, TP 140.30

Risk = 30 pips, Reward = 30 pips, ratio 30/30 = 1

However, if you add a 3 pips of spread, you change the equation:

Buy EUR/USD @ 140.00, = 140.00 BID / 140.03 ASK, real entry = 140.03

Therefore, SL =33 Pips, TP 27 Pips or 33/27 = 1.22 R/R ratio

If you change the equation and look only for 20 pips of TP/SL:

Buy EUR/USD @ 140.00, = 140.00 BID / 140.03 ASK, real entry = 140.03

Therefore, SL = 23 Pips, TP 17 Pips or 23/17 = 1.35 R/R ratio

If you change the equation and look only for 10 pips of TP/SL:

Buy EUR/USD @ 140.00, =140.00 BID / 140.03 ASK, real entry = 140.03

Therefore, SL = 13 Pips, TP 07 Pips or 13/07 = 1.86 R/R ratio

Therefore we use a default 30SL/30TP for the most reasonable R/R ratio…

Of course you can get better R/R by increasing SL/TP to 40~50, or even 100 pips, but that would be impractical…

 

About Kelvin Ching

I'm a professional Forex trader and I have been trading for over 7 years. I was a series 3 broker and a registered CTA with the NFA, the main regulatory agency in the United States, and I have been involved at the highest levels in commodity trading. I also have a background in Information Technology, graphics design, and programming... I'm the co-founder of CurrencyNewsTrading.com, a site dedicated to fundamental analysis and news trading.

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