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Risk to Reward Ratio Explained

Risk to reward ratio is used by traders and investors to calculate the ratio of potential gain to potential loss in a Forex trade. Mathematically, this ratio is calculated by dividing the amount of the expected profit with the amount of the assumed risk.

Risk to reward ratio = Risk (potential loss*)/ Reward (Potential Gain**)

Before jumping into the market, traders should know how to calculate the risk/reward ratio and how it is applicable to trading. Risk is the most certain and dangerous aspect of trading. Every trade carries some amount of risk and it is essential for traders to know how much risk is present in a particular trade and how he/she can minimize that risk, so that their trading capital is protected. The best way is to calculate it is by using the risk/reward ratio.

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For example, 1. If the trader is taking a risk of 1 pip to get the profit of 2 pips, then the risk/reward ratio is 1:2 2. If the trader is looking for a profit of 100 pips, with a tight stop loss of 75 pips, then the risk /reward ratio is 75:100 (75/100), which is 0.75. 3. If the trader is expected to earn the profit (reward)of $1320, with a stop loss of $350, then the risk /reward ratio is $1320:$350($1320/$350) or 3.7714:1.

How do you determine the risk/reward ratio? Step 1 Risk – The very first step for a trader is to determine that how much risk is he/she is ready to assume on a particular trade. Stop loss is the best way through which traders calculate the risk value. Step 2 Reward – Reward is the profit on an investment. Basically, this is the gain in currency pair value that a trader is hoping or attempting to earn from the currency price movement. Example1. Let’s say a trader has an account with Easy-Forex and deposits $5000 in his/her account for 20:1 leverage. The trader can trade with $100000 with the help of leverage and decides to take a risk of only 2% of his/her trading capital, which is $100 ($5000 * 2%) and to book profits, when the trading amount goes above $200. It means he/she will be out of the trade, once he/she is either -$100 or +$200. Hence, Risk/Reward Ratio is = 100/200 = 1:2 Key TakeawaysRisks and reward are two sides of a single coin. Every one wants the reward side of the coin but nobody wants to accept the risk. Burying your head in the sand will not make the risk go away, but taking it out and doing a little homework will definitely make the risk hurt a lot less. The risk and reward ratio clears the loss that a trader will be looking at, from a potential Forex trade.

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