Risk/Reward Ratio – a tool in the money management system
There is a saying in the trading world that if you are trading without a stop loss and without having a proper risk/reward ratio you are doomed to failure. From my point of view this holds true only to a certain extent as it depends very much of the type of trader one is: scalper (meaning going for short term profits, taking quick bites out of the market and having as many entries as possible during the trading day) or a medium term investor (there are traders that do trade currencies based on the higher time frames charts, from the daily up to the monthly charts). So the statement above would most likely address the second category of traders mentioned here, as scalping can be very successful without having to employ stop loss and risk reward strategies.
On the other hand, a medium term investor is the one that resembles the professional trader, in the sense that his/her analyses are based on analyzing the market from both the technical and fundamental point of view. While the scalper will mainly look at fundamentals only to the extent of the moment of time the economic data/indicator is released, the investor looks to understand why a specific economic data came in the way it did, what it means for the currency, and how to trade that into his/her advantage.
Identifying a possible new trend does not mean the medium term investor will jump and take the trade just like that, but will look most likely for the setups that provide the most attractive risk/reward ratio.
A risk/reward ratio should be defined as the ratio between how much you are willing to risk for a specific outcome. For example, if a trader decides to go long eurusd at the 1.30 level and uses a stop loss of fifty pips, or 1.2950, and a take profit of 100 pips, or 1.31, the risk/reward ratio is 1:2, meaning for every pip risked, there are two pips of potential profit. The higher the ratio, the better, and traders strive to identify the proper setup to have this ratio as big as possible.
A good risk/reward ratio (also called rr ratio) is considered to be the 1:3 ratio, and there are traders who are effectively refusing to take some trades if the rr ratio they are basing their trading is not there and such rules are part of the money management system each and every trader should have.
The medium term investor will always look for those setup that provide the rr ratio they are looking for and because of that they already have a competitive advantage in front of scalpers as one successful trade with a 1:3 rr ratio should cover for three potential bad trades. And this is why the rr ratio should be incorporated in any money management system a trader uses.
However, there are some negative points related to trading with a specific rr ratio as markets spend most of the time in consolidation and having a big rr ratio implies one should trade only when markets are trending/moving. This depends very much on the risk taking, as the same rr ratio can be traded even when markets are not moving that much, so taking a lower risk will definitely be a way to go. But currency markets are characterized by extreme volatility levels and frequent spikes and that makes it difficult, if not virtual impossible, to find entry levels that assure a nice rr ratio starting with the smallest risk possible.
All in all, trading with rr ratio helps traders be more disciplined and trading is one area where discipline is needed if one wants to be successful.
The primitive forces of capitalism rule markets like the laws of gravity. Buyers and sellers provoke a battle to find a happy medium agreement in every market on the face of the planet.As prices dance around on charts, traders are often looking to a number of reasons to explain price movements. And often-times, a number of reasons can be associated with these types of changes.But at its core – every single price movement is denominated by supply and demand. Positive news means increased demand and lessened supply – equating to higher prices. Negative news usually spells lower demand and increased supply.Supply and Demand Spelled OutSupply is simply the amount available, while demand is the amount that is wanted. Think of supply and demand in the most simple of terms, from the standpoint of any market where buyers and sellers exchange goods. Let’s, for a moment, imagine that you are selling oranges from your own farm at a local market. And you don’t necessarily have to sell all of your oranges, because, after all, you can eat them just as easily as anyone that buys them from you.But the higher price you can charge for your oranges, in general, the more willing you would be to part with them. If oranges are only fetching 1 dollar per bag, you might be willing to sell 4 or 5 bags. But as price goes up, you decide to make more available. All the way up to 10 dollars per bag, at which point you are more than willing to sell every last orange you have because you can easily take all the money you made and buy something else to eat.The graph below is called a ‘supply curve,’ and it expresses this relationship. The red line indicates supply, which increases as prices move higher (located on the horizontal axis). Supply curve, expressing the number of units available (vertical) at various prices (horizontal) And on the opposite end of the spectrum, we have demand. Now think of the buyer-seller relationship from the vantage point of the consumer. The lower the price, the higher demand will be – the exact opposite of our supply curve. If oranges were only 1 dollar per bag, we’ll we’d want to buy as many as we could because it would be an extreme value. As price increases, our demand weakens because, after all – if oranges are 10 dollars per bag – we can easily find replacement products to use instead of oranges. Demand curve, expressing the number of units desired (vertical) at various prices (horizontal) And these two competing forces meet in the marketplace to decide the prices that will be paid and the number of units that will change hands.This is how price is discovered in a free market environment, the same way that prices are set on trading platforms around the world and it can be expressed in the chart below: Supply and Demand curve, expressing the most efficient price at which buyers and sellers can meet Supply and Demand in the Forex MarketThe analogy of oranges at a farmer’s market is not all too dissimilar from that which takes place every day in the currency market. In some cases, these forces are moving at such high velocity that new traders can have difficulty understanding the granularity of the details; but rest assured - the forces of supply and demand run true to markets whether you’re looking at a tick chart or real estate prices.The FX market is one of the most voluminous on Earth, and the reason for that is the heavy demand behind the traded assets. Currencies are the basis for the world’s economy. Whenever one economy wants to trade with another economy (provided different currencies are used) an exchange will be required.Supply and Demand at WorkImagine that the Reserve Bank of Australia enacts an interest rate change. An entire chain reaction will be set in motion due to the forces of supply and demand. When rates increase, rollover payments also increase. This means that investors that are holding the trade open at 5pm Eastern Time will receive a higher rate of interest than they would have previously. Incentive has just increased.So naturally, more traders will want to buy; and fewer traders will want to sell as the opportunity cost of doing so (the rollover payment) has just gotten more expensive. An example of supply and demand in response to Interest Rate Increase Price aims to find a comfortable point, and will increase until there are no more buyers willing to pay that price. At this point, sellers outnumber buyers, and price will respond by moving down.The Forces of Supply and DemandAn example of supply and demand in response to Interest Rate IncreaseAfter price has moved down far enough (circled in blue), traders will come back into the picture, remembering in the increased interest rate and the additional rollover payment that can be had from holding a long AUDUSD position, and this lower price presents a ‘perceived value.’ As additional buyers enter the picture, price will move up to reflect this increased demand.And then price will, once again, move so high that traders no longer want to enter the picture at that price level, and price will respond by moving down.This is but one example of the Supply and Demand relationship; on one time frame… we can even see this relationship playing out in the tick chart of any currency pair.This is the process of price attempting to find its fair value… it takes place on many different time frames in every market in the world.In our next article, we’ll tie supply and demand in with support and resistance so that traders can look to use these principals to their advantage.
It is always god to investigate what the best Forex brokers promise their traders. Black Diamond broker for instance made some attractive and unrealistic promises that the traders would have easily spot. As an illustration, they promised a four percent return to traders every month. It would have flashed a warning sign. If you are aware of the Bernie Madoff scenario, you would remember that during the scandal experts criticized the company for unrealistic promises when the company only guaranteed investors a 10 percent annual return. Another sign of an FX broker scam is the company itself. For example, Black Diamond Capital Solutions, LLC, founded by Keith Simmons was never licensed to operate as an investment firm, neither was it regulated by the CFTC in the US. This is why it is always essential to do your research on the legitimacy of a forex company before you invest with it to be sure that they are regulated. Gerald Leo Rogers founded Premium Investment Corp., TriForex International Ltd, and InForex Ltd, in just a single year. Isn’t that enough warning sign? The Scammer had stolen nearly 30 million dollars of clients’ funds before being caught. Even then, he only refunded 11 million dollars. The scam managed by Rogers was quite tricky because the transactions were carried out outside US, which made it difficult for the authorities to recover the money back. Things you can do to stay away from These Forex Scams Most scammers are as a rule very clever people. There’s no way an idiot could put together a scam that made tens of millions of dollars. But, if you can follow these tips, you will be much less vulnerable to scam in the future: Perform Your Due Diligence On The forex broker It’s recommended to find out if retail Forex broker is licensed and regulated, but you also need to find out everything you can about the company itself. Before you make that deposit, find out as much as you can about the forex brokerage company. In the case of Black Diamond, if the investors have carried out research it wouldn’t have taken them time to recognize that there was something suspicious about it by looking at its structure. First, it wasn’t licensed to operate in the US and not regulated by any financial regulator. Also, it wasn’t even based in the US. As for Gerald Rogers, the chap had earlier been convicted of fraud and was in fact on parole when he launched Premium Investment Corp. Evidently, these two major FX brokerage scams could have been avoided by carrying out a simple research into the companies and their founder. Check credible reviews from verified users of the broker Make Google your friend before making the leap. You can also use this resource to learn more about a Forex broker and avoid Forex brokers’ scams. However, you need to be wary where you source your information because there are some review websites that the fraudulent brokers themselves use to spread the fake positive news. It’s not easy selecting the good review websites from the bad, however, you should check if the comments appear inconsistent. Be Careful Of any promise that appears too good to be true In the first case of Black Diamond, the most noticeable sign that it was all a Forex brokers scam was in the extent of promises made. Don’t forget that when the deal is too good, think twice. And if it is extremely good, assume the worst and run. Look for any signs where the broker tries to talk you down about the risks involved. Forex trading is a very risky venture, even riskier than most other investments. Thus, if the broker says that there are minimal risks, just assume that they are lying. The most recent Forex regulations set out by MiFID II require that all Forex brokers indicate clearly that Forex trading is extremely risky. Moreover, they must warn traders about the possibility of losing more than their initial investment. Hence, do not believe anyone who claims tells you there are only minimal risks involved.
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