I want to start the course about this topic because it is one of the reason lot of new traders don’t make money long term. Some make few pips and they think them going to be rich, but because of poor money management, they end up blowing their account. With poor money management, they are no strategy that will work for you I can guarantee that one because they are no 100% no loss strategy that I know to believe me I have looked for it as well.
Whenever you place a trade you are exposing your account to a risk set by yourself by how much lot size you use and how far your stop loss is set, if you use 100% and if you are wrong all your money will be gone. As I said losing is part of the game in forex but we need to manage it to our advantage in order to have a profitable trading life. A profitable trader will not risk more than 10% of his/her capital, I risk 2% on my account. How do u ensure that you can control your capital risk by winning big and losing small? The secret is controlling your risk to reward ratio.
RISK TO REWARD RATIO
A risk to reward is how much you are risking per that trade compared to how much you will gain. A risk to reward can be positive from 1:1 to 1:2 or 1:4 or even higher. The lesser the risk with higher reward the better for you as a trader. Below I have prepared a table to demonstrate how risk to reward affect the account of different traders, I’m going to use Mark, bill, and Tommy. I will give them all fictional starting capital of 1000 USD, we want to see how much they will have after 10 trades. Let assume that they all use the leverage of 1:1 and all risking 10% of their starting capital per trade.
|Mark ( 1:1)||Bill (1:2)||Tommy(1:4)|
|Starting capital = $1000|
|1st trade loss||-100||-100||-100|
|2nd trade win||+100||+200||+400|
|3rd trade win||+100||+200||+400|
|4th trade win||+100||+200||+400|
|5th trade loss||-100||-100||-100|
|6th trade loss||-100||-100||-100|
|7th trade win||+100||+200||+400|
|8th trade win||+100||+200||+400|
|9th trade loss||-100||-100||-100|
|10th trade loss||-100||-100||-100|
|TOTAL = (5 WINS & 5 LOSSES)||$ 1000||$ 1500||$ 2500|
I’m sure you are wondering now how is it possible that all traders had the same amount of starting capital and risk same percentage amount and the same win percentage of 50%, but their account grew at a different rate. Well, that where the risk to reward comes in to play. With great risk to reward, you can get correct 3 trades out of 10 but your account is positive. Magic heh? I only enter a trade if I have min 1:2 risk to reward only.
What I showcase here is positive risk to reward ratio, what about the negative one. Anything below 1:1 is the reason why a lot of traders blow accounts. Right now I will show you how negative risk to reward is bad for you and why you should pay attention to it. Below is a table showing 10 trades of JEFF, he will have same starting capital and conditions as other 3 traders we had on positive risk to reward ratio.
|Starting capital = $1000|
|1st trade loss||-200|
|2nd trade win||+100|
|3rd trade win||+100|
|4th trade win||+100|
|5th trade loss||-200|
|6th trade loss||-200|
|7th trade win||+100|
|8th trade win||+100|
|9th trade loss||-200|
|10th trade loss||-200|
|TOTAL = (5 WINS & 5 LOSSES)||$ 500|
So what do you think of JEFF odds of succeeding as a forex trader, they are not good; not because he’s a bad trader but because he has bad money management skill. Now you see why managing your risk is very important. They is a saying in forex that “when you win you must win big and when you lose you lose small”.
In the introduction, I promised you that with Elliot wave controlling your risk to reward is easy. Well, it true so just relax I’ll show you just how easy it is
Looking at the diagram on the left shows by following the rules, how easy it is to set your stop loss and take profit. Also, check our risk to reward ratio, we are risking small and winning big. Your question must be why I put my stop loss where it is? As I said they are rules we follow in Elliot wave which I will cover on the course in detailed. Just to summarize them so that you can understand the setting of stop-loss:
- rule #1 – wave two must not go beyond the start of wave 1
Rule #2 – wave four must no come back to touch the prize range of wave #1
By using those two rules you can understand why I set them to be where they are. As a trader you must understand how to set your stop loss correct, it must be in a place that will show you that you were wrong .let look at another diagram of the real chart because we trade using charts not cartoons, this is NZD/USD chart of 4-hour time frame in 2017.
Just to explain if they is someone who doesn’t understand, let say you bought the pair in entry #1, your stop loss should be placed below beginning of wave 1 according to RULE #1 we shouldn’t go below start of wave 1, if it does go below you need to double check your counting. Now you have stop- loss set good, your take profit will be determined by your wave counting of wave 3, I’ll explain in the main course page but wave 3 should be 5 waves. If you missed Take profit #1 don’t worry they is still #2, and another chance to enter at the start of wave 5.
Now you have your stop-loss set good, your take profit will be determined by your wave counting of wave 3, I’ll explain in the main course page but wave 3 should be 5 waves. If you missed Take profit #1 don’t worry they is still #2, and another chance to enter at the start of wave 5. If you are experienced like me or you after this course you will take both profits and that some good profits. You notice my risk to reward ratio for both trades, it roughly 1:4 for both. Remember the lesser the risk and higher the profit the happier your account will be.