When trading a forex currency pair, one of two things could happen – the price could either go up or down. Your job as a trader is to be on the right side of this move. That is predict it correctly. Alright, so we have two possibilities, that is essentially a 50/50 chance either way. Here lies the problem: If you win one, lose one, win one, lose one, etc how do you make money? Simple, all else equal, you will not!
To make money trading forex you need to have some form of edge. You either need to be able to pick the market correctly more than half the time (this is known as a positive win rate) or, win more than you lose on each trade (known as a positive risk to reward ratio). The best forex traders will do both and achieve great success – not only do they pick markets right more often than not (this comes with experience), but they win more than they lose on each trade as well.
Imagine this: You place four trades, winning two and losing two. On each trade, you have a stop loss of 10 pips and a take profit level of 20 pips. What is your net result? +20, +20, -10, -10 = +20. You have not got any better at picking forex markets since the first paragraph, but you are now trading with a positive risk: reward ratio. Instead of breaking even, you are now profitable! Your breakeven level falls from 50% to 33.33%. This is a 1:2 risk to reward ratio – your average losses are half the size of your average wins.
This is an example of a 1:2 trade – we are long EUR/USD, risking 80 pips to potentially make 160:
Note we could squeeze 1:3 out of this range:
If making 1:3 trades, you only have to be right 25% of the time to break even.
If you want to make money trading forex you have to have some form of edge. Find your trading edge with VT Markets.
