Risk to reward fallacy

Let’s talk about risk to
reward ratio. This is something controversial, because setting a fixed RR
(reward to risk) like 3:1 isn’t fully wrong, but it isn’t even right. You need
to understand that there are no certainties that your trade goes to the target,
it may reverse at 1:1.

You may say „yeah,
but I would have already put my SL at BE (breakeven) by that time, because I
trailed it“ and you would be correct, but what if all of your 3:1 trades
end up at breakeven? Your account would be actually down a little because of the commissions
you paid. You would have worked hard for nothing.

That’s why you shouldn’t
have a fixed rule like that, in trading you need to adapt, be flexible and
proactive. Your soft target may be a technical level like a strong support or
resistance zone, or maybe a Fibonacci extension level and so on, but your trade
should remain active until you see that the reasons for the trade
have changed, or you lost conviction in it.

If your reasons are still
there you can keep it active or maybe you can take some profits off the table
at different times and let the rest run. You can also manage the trade by
trailing your stop loss behind strong swing points for example. But if the
reasons aren’t there anymore just close it and get what you gained instead of
hoping and losing all your gain exiting with a BE trade, or worse a loss.

You can even cut your
losses limiting them to a fraction of your original risk, there’s no need to
holding just because of hope. You can see that this way your trade can even
turn into a 5:1 or more and that will compensate for your losing trades. Remember
that it’s not about being right or wrong but how much you make when you’re
right and how much you lose when you’re wrong.

This article was written by Giuseppe Dellamotta at www.forexlive.com.

Go to Forexlive

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