When entering a position you should know what your attempting to make on the upside (reward) versus how much you can lose on the down side (risk). My personal minimum reward-to-risk-ratio is 3 to 1. Which means I’m attempting to make three times as much as I’m willing to risk. Theoretically, all variables aside, if you are to implement a 3 to 1 reward-to-risk-ratio you can be wrong 75% of the time and still break even. Some of the best traders in the world are wrong more than they are right. However, when they are right they are right big and when they are wrong they keep there losses small.
How do you figure out your risk-reward when going into a trade? Your risk is the easier of the two to see. You look for nearby support where you can place a sell-stop below, the diferrence between the current price and the sell-stop is your risk. Trying to figure out your upside potential (reward) takes some knowledge of technical anlaysis. You have to know how to calculate your upside targets bases on chart patterns, which I will discuss in the next blog. Once you know your upside target you subtract that from the current price and that is your reward. Then, take the reward figure and divide by the risk number and you will have your reward-to-risk-ratio. My rule of thumb is a ratio over 3 is worth considering, below 3 look else where. Stay tuned to the next blog to calculate upside targets…
