2:1 Risk Reward Ratio - How it can help you add profits to your trades

There is a rule out there that many forex investors and speculators use. It's a rule of trading that can help govern your activities in a good way. The rule is Risk Reward Ratio (I sometimes call it the Triple R)

Risk Reward Ratio is a good way to temper your trading activities and protect your starting investment. The golden number for this ratio is 2:1 - Remember that ratio!! Live it, Breath it, Eat it. That means that you will only risk 100 pips to gain at least 200 pips - This ratio is not only used in forex trader's discipline but also for stocks and commodities, bond's and t-bill etc.

This ratio should help you decide whether it is worth getting into a trade or not. Lets Take a look at how I use it for my trading and how it benefits me. Every trader will have a personalized approach to it so take this to your head and use it to help you with developing your own approach.

This explanation will not mention the use of stops

Lets look at a chart to help me explain:
Here is a 1 hour chart of EUR/CAD As you can see the price has risen nicely. 2500 pips is a nice rise especially in only a short couple months. That rise represents a potential to fall (correct) back down. In some cases a pair may indeed retrace and fall it's entire gain, that represents a risk. A risk of 2500 pips!



Now lets look at a weekly chart to get a larger range picture:

To help us get our total risk assessment for this pair I like to look at the weekly charts and I tend to use 600 - 800 bars or candles. This pattern looks very suspiciously like a "Head And Shoulders Pattern" And could help us in making trade decisions. (A head and shoulders pattern is one that is very common in the markets and usually indicates tops or bottoms) and in some cases marks a pairs range. We can see the EUR/CAD pair's range is from 1.2500 - 1.8911 - That gives us a bit of insight to where this pair may end up 100 weeks from now. If the pattern fill out and completes itself we will have a EURO worth 1.25 Canadian Dollars (or so) That gives us another 1500 pips to the top of the second shoulder, if we go long - if we go short we are risking 1500 pips to the top area of the pattern - Which has the largest gain potential 1500 upwards vs. 5000 downwards? This would represent a risk reward ratio of 3-1 (roughly) in the plus if you go with downward bets - in the negative if you go with upward bets.

If you were betting on an 8 year investment duration, your best reward would be downward direction for a 5000 pip gain, while your risk would be somewhat limited to only 1500 pips should it take off to the top of this pattern. That is a 3:1 gain and would make a bit of sense when investing. If you were going upwards you would potentially gain only 1500 but would have risked 4500 to do it.

Maintaining a ratio of at least 2:1 in your favour will help you decide if it's worth getting into a trade of not.