One of the essentials of trading in any investment market is establishing a risk management plan.آ  New traders often jump into the market head first with no real pre-determined trading plan.آ  The outcome can be disastrous in a short period time.آ  The Forex market, just like other investment markets such as the stock market and futures market, require a trading plan that’s free of emotion and heavy on discipline.آ  Only then can a trader’s hard earned money and valuable time translate into respectable profits.آ 

The risk-reward ratio

The risk-reward ratio is basically the risk you’re willing to take to make a certain profit.آ  Any risk management plan that’s worth its money has a decent risk-reward ratio of at least 1:3.آ  What exactly does a 1:3 ratio mean?آ  It means that for every unit of risk you take, you’ll reap three times that amount in reward.آ  A 1:4 ratio means that for every unit of risk you take, you’ll earn four times that amount.آ  The larger the ratio is, the greater reward you make.آ  However, with higher risk-ratios, you’ll have to wait longer to make that trade.آ  You might end up missing some lucrative trades in the interim, and your “idealâ€‌ trade might never show up.آ 

Here’s how it works

Let’s say you risk 50 pips (units) to make a deal worth 100 pips.آ  You’re risk-reward ratio is 50/100, or 1:2.آ  If your risk management plan limits your trades of at least a 1:3 ratio, then you shouldn’t make the trade.آ  However, if you risk 50 pips for a potential 150-pip gain (50/150 or 1:3), then it’s worth it.آ 

What about risking more than you can make?

Some investors don’t mind risking more than they can make on a deal.آ  Is this real good advice to follow though?آ  If you’re a real risk taker, then take the chance.آ  But if you’re in the market to make a real profit over the long run, then don’t do it.آ  It is just not sound risk management planning.آ 

Suppose you want to risk 100 pips to make a potential 50 pips.آ  Your risk-ratio is 100:50, or 2:1.آ  That means that you’re willing to give up more than you can make on the deal – not the best logic.آ  True, you can make 50 pips, but you’re risking more than you can even make on the trade.آ 

tip from golearnforex