The risk:reward ratio is vital to a day and swing traders' successful strategy. Combined with proven technical analysis strategies, it can lead to regular steady profits.
The risk:reward ratio applies to the stop loss point and the target point of a trade. The risk being the point you place your stop loss and the reward being the point at which you close your trade.
The golden rule of risk:reward is that from each trade your reward should be at least 3x your risk meaning the risk:reward ratio should be at least 1:3.
This is based on the theory that if only 33% of your trades are successfully then you will still make a profit. Example;
- Risk [1] £100 : Reward [3] £300 - trade loses - £100
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Risk [1] £100 : Reward [3] £300 - trade wins - £300
- Risk [1] £100 : Reward [3] £300 - trade loses - £100
- 3 trades, 33% win ratio, £100 profit!
Ok, this is only a basic example but the theory works. This is a major benefit to a trading strategy, it means you don't even have to be successfull most of the time on your trades and still make a profit! If you trade regularly or want to trade regularly and don't know about the risk:reward ratio then I suggest looking at some stock market courses to improve/generate your strategies.
If you live in the UK, WinInvest run a free seminar teaching you stock market basics and explains the risk:reward ratio in more detail, obviously they don't give away all their secrets for free but having been on the course I recommend going along to the free taster seminar.
