Hello,
Does this mean that every trade you place must be with the same $100 stop loss and $200+ take profit with every trade? (I know this will change as your account grows/diminishes). Using a 2:1 ratio would mean we can afford to lose twice as many trades than we win in order to breakeven. But this only applies when all your TP and SP levels are set the same as all previous trades. How can you manage risk if you use a smaller position such as $100 TP and 50$ SL or $10 TP and 5$ SL? Or a larger one like $500 TP and $250 SL. One bad trade with a different TP/SL size would ruin the supposed 2:1 ratio of being able to e.g win 100 trades and lose 100 trades and still come out with profit.
thanks
jackyjoy
Few things come into play:
- Profit Loss Ratio = this is how much you may win or lose at single trade. So basically your average profit to your average loss (or Take Profit vs Stop Loss, if you’re not using any more sophisticated exit strategies)
- Win Rate = What percentage of good trades you may expect (roughly). If your system has 80% win rate, you don’t have to stick to 2:1 profit/loss ratio, as even with 1:1 you would come out profitable in the long run
- Stop Loss / Position Size - You must know where you would close a trade before getting into one. Once you have this level you need to calculate how large position can you open to not risk too much.
- Value At Risk - how much actual money you want to risk on single trade. Tribal knowledge says it is best calculated as some small percentage of your account, e.g. 2%
1 Like
Hi and welcome to the forum.
The often quoted “plan a 2:1 take profit” is merely one of hundreds or thousands of alternative plans. In my opinion, using a target of 2:1 ratio is doomed to failure, but that is just my opinion. I would wait until I have read (and understood) a lot more about Forex before deciding a plan. I have been at this for many years and still don’t have a plan that I know has a lasting edge.
First, risk management is about ensuring that each trade does not expose your entire account to too much risk of loss. In this respect, it would be a good idea to limit your trade size to 1% of your capital. So even if you have a $10,000 account, you would be risking only $100 per trade.
Second, it is how you decide that that $100 represents in terms of stop loss. If your stop loss is to be limited to $100, and you know that the basis of calculating the maximum loss in PIPs that represents $100, then you have calculated your lot size. Depending on the pair you trade, that can vary enormously since not all pairs have the same volatility.
3 Likes
You’ve touched important thing, I think is not underlined enough in various FX sources - money management is about keeping you in the game, not winning the game 
In every financial market, money is the resource we use to (hopefully) create more money.
We also know, that it is VERY hard to have strong edge (> 65%) which means, that we are exposed on multiple losses, which are part of the game.
To keep playing, we need to be able to suffer multiple consecutive losses and still have enough resources to eventually profit due to slight edge (win rate). This is very similar to gambling
What is important - win rate (edge) is impacted by your profit:loss ratio. This is also very often overlooked. you will have much higher win rate with 1:1 ratio than with 20:1. It depends on your system where it shows more potential (expected return). For 1:1 you need to have win rate > 50% to profit in the long run. For 20:1 you should be good with > 5% win rate. So take your strategy, test with different TP/SL ratios and see what will give you higher expected return (if any).
As @Mondeoman wrote - it is very hard to find long term edge. For starters, if you find anything above 50% and tested through different market environments - you should be happy
1 Like
Hi
Probably the best book I have read on this matter is Mark Douglas - Trading in the Zone. In fact, I have read it three times from start to finish, the last time being May 2021. The first being 2011. They say that you can read something once, and not understand the key messages. You can read it a second time (after some supporting other knowledge and most importantly some real world experience), and you start to see the messages. Many traders on this forum have read this classic book, or other similar ones. I started to see all the mistakes I was making - analyzing my trades after the events. Sometimes winning when I should have lost, sometimes losing when I should have won. In my last flurry of actual trading I had 440 trades until I realized the edge was still -3%. Now I am back to the drawing board with yet another attempt at getting my strategy and plan right. Time is on my side. I do not “need” to earn profit from trading to live my life, but nevertheless, if I can find that golden plan that gives me a consistent edge I will consider that to be one of the greatest achievements of my life.
Other members may suggest other reading material, but in my opinion there is no substitute for writing down the plan, implementing the plan with as few variations as possible, analyzing the results and trying to eliminate the errors one by one until you can say you have an edge. Far easier said than done, but I am over the other distractions like psychology and impatience. Those went away about 3 years ago. Now it is just a matter of measurement and continuous improvement.
@Mondeoman Re-evaluating a trading plan is as important as building a new one. The Forex market is one of the largest markets in the world and that being said, the market conditions keep changing continuously. A trader should always be able to find loopholes in his trading plan and make adjustments in it.
Not sure that leverage changes requirements to win rate, with 20:1 leverage 5 wins with 5 losses will produce 0 return despite the fact that win rate is 50%. Leverage changes magnitude of returns when compared to equity.
We’re Talking about risk to reward ratio 20:1 not leverage.
So, actually stop-loss should be set by the way it won’t bring you any money losses. For example, if you open a bullish position and the price of an asset is 30$ (for example pick some tech company), then stop loss should be approximately 28$ and no lower, because then you will lose lots of money. In my opinion, stop loss is a great feature in trading activity which is helpful for minimzing risks. Moreover, this position, which you had opened for the price of 30$, should be complied with your risk management strategy. I mean you should have 1500% of deposit in order not to put your deposit under high risks.