This is the third post of the trading series. In this post we will learn basics of risk reward ratio and where should we use it and where should we not use it. This is yet another important topic in trading.

What is risk reward ratio?

It is the ratio of how much you want to risk to gain certain percentage of money. It is very important to manage risk reward ratio before starting to trade and work accordingly. It will help you to control your emotions in trading.

Example of risk management

For example you have a trade, where you think you can make 15% profit and you can place stop loss at negative 3% safely, then your risk reward ration is 5:1. And let's suppose trade didn't went in direction you expected. You will loose 3%. You can do this same trade 5 times and even if you loose for 4 times and win 1 time, you will break even. And since we are using trading strategy (which I will teach you in later courses) your winning chance will be more than 50%. That means you will be winning around 3 trades out of 5.

When to not use risk reward ratio?

When trading, your trade is very strong and there is strong trend, you can keep trailing stop loss and not use risk reward ratio. Trailing stop loss is a moving stop loss. For example your stop loss is at 3% and market moves 10% up and 10% is your reward top. But you think market will certainly move up, then you can keep stop loss at 3% again. Now even if market goes down, you will still be in 7% profit and if market goes up, you are in more profits.

Trading course series - #1 - Introduction

Trading course series - #2 - Risk management