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Lesson no. 14:

"Profit and Risks"

Reading will take: about 10 minutes

The ratio of risk and reward in trading or the profitability of transactions is one of the most important aspects of your trading strategy. This helps to protect against high risks, allows you to use capital efficiently without risking most of it.

Contents 14 lesson:

Risk to reward ratio;

Risk calculation - examples;

Popular profitability ratios;

How does it work, why is it needed?

The risk / reward ratio is used by many traders to compare the expected return on a trade with the amount of risk you take for profit.

To calculate the risk to reward ratio, you need to divide the potential profit by the size, or the Take Profit value by the potential risk or Stop Loss size.

Of course, there are other aspects that can affect the riskiness of the transaction, such as: money management, price volatility. The right balance of risk and reward is an important point.

Risk calculation

Suppose you want to open a trade on the EURUSD pair. You predict that this quote will grow by 100 points, this is your potential profit. You also expect that if the price falls by more than 90 points since the opening of the deal, then your forecast will not come true. In this case, you will need to close the deal, this is your risk.

Thus, your potential profit is 1000 pips and your potential risk is 900 pips. Let's calculate how much it will be in dollars. Let's say that you open a trade with 0.10 lots, where each pip is worth $ 0.10. We multiply the number of points by their value: 1000 x 0.10 = $ 100, 900 x 0.10 = $ 90.

Thus, we see that our risk is limited to $ 90, this is the size of the maximum loss that we put into the trade. Our potential profit is $ 100.

In order to determine the profitability of a trade, we need to divide the potential profit by the potential risk: 100: 90 = 1.1. Our trade ratio is 1.1. Obviously, this deal is not very profitable, so it is better to refrain from opening such a deal.

Popular profitability ratios.

The vast majority of traders open deals with a profitability ratio of at least 2. This means that their potential profit is always 2 times greater than the potential risks.

For example, if you are willing to risk $ 100, then your potential profit should be no less than $ 200. So your risk is $ 100 and your profit is $ 200. In this case, the risk to reward ratio is 1 to 2. The most popular ratios are 1 to 2, 1 to 3, etc., incrementally.

How it works? Why is this needed?

High ROI trades help you offset losing positions.

Consider the following example:

You have opened 10 trades during the week. Each trade was opened with a risk-reward ratio of 1 to 2. You put the risk on each trade no more than $ 100. The potential profit on each trade was $ 200.

Suppose that 60% of your trades, 6 trades out of 10, brought you a loss. A total of 6 trades of $ 100 each brought a total loss of -600 $, and 4 trades with a profit of $ 200 each brought a profit of +800 $.

Thus, most of the trades brought you a loss. As a result of your trade, you received a profit of +200 $.

What would happen if your ratio was 1 to 1, that is, your risks and profits would be equal? In this case, you would earn and lose $ 100 each, since 6 trades would bring a loss of $ -600, and 4 trades would bring a profit of +400 $. In this case, with identical trade statistics, you would have received a loss of -200 $.

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