Before placing a trade, traders should look to contain their risk. Its inevitable that a new trader will want to dive in head first into the market, and immediately enter into their first Forex trade as quickly as possible As tempting as this may be, more often than not, traders will also forget the risk management aspect of their tading idea.
Proper risk management is imparative to any trading plan, and allows us to know exactly where we whish to exit the market in the event that price turns against us. Knowing this ratio can help traders manage risk by setting expectations for the outcome of a trade prior to entry.
The key here is to find a positive ratio for your strategy. This way we increase the margin of profit when we are right, relative to the amount we lose if were wrong. Traders looking to trade a trade this range would expect to enter the market off overhead resistance near. When setting exits on a range trade, stops should always be set outside an indicated level of support or resistance. In this example stops are set above current resistance near.
In the event price breaks through the depicted range, we would be expecting to lose 50 pips on this trade. To create a 1: Understanding these ratios can actually help individuals avoid the number one mistake that traders make.
After sifting through over 12 million trades, FXCMs analysts were able to calculate that while most trades are closed at a profit, losses still far exceeded profits due to traders risking more on losing positions than the amount gained from a winner. In the graph above, we can see that the average profit on the EURGBP is only 30 pips, while the average loss is closer to The easy way to avoid this scenario is to use at minimum a 1: This maximizes profits on winning trades, while limiting losses when a trade moves against you.
By risking 50 pips to make a reward of pips in the trade above, we are effectively inverting these statistics in our favor. Meaning now, we only need to have one winning trade for any two given losers to be break even to net profitable on our trading account.
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