When approaching financial markets, traders must have a plan. Because it eliminates the emotions in the Forex trading process, a trading plan is a must between professional and retail traders alike.

After all, if the plan was to buy or sell a currency pair at a specific level, then executing it is the plan’s implementation. By the way, as a separate note, the existence of a trading plan and its execution are two different things.

Some traders can’t pull the trigger. Either entering a trade or exiting one, they’re not able to push the buy or sell button.

Many factors are responsible for this hesitation. Ego, lack of market understanding, correlations, fear, greed, etc., to name a few.

If traders can put emotions aside the trading part becomes more comfortable. More precisely, much easier than anyone would think.

One thing helps to reach that: back-testing. Nowadays the trading platforms offered by most brokers allow running sophisticated strategies and testing them on historical prices.

This is good and great, but the old fashion paper-trading tells much more about a trading strategy than a software doing some back-testing. We’re not talking about trading on the one-minute chart or other lower timeframes, but trading from the hourly and above.

Seeing with your own eyes how the price action revolved around the entry and exit of a trade gives much of an insight for adapting the trading strategy in the future. In the end, paper trading for a while lets a trader see what works and what doesn’t work in Forex trading. Like, for instance, what is the best risk-reward ratio to use in the currency market.

The Road to the Proper Risk-Reward Ratios

We’ve already covered much about what a risk-reward ratio is and how it helps in successful Forex trading. The risk represents the distance from the entry price until the stop loss.

However, it also represents the amount risked. Moreover, the volume dictates the potential amount risked.

Hence, they all go hand in hand when setting the risk-reward ratio.

In any case, regardless of the way you look at the risk (distance in pips, volume, amount, etc.), the reward must exceed it. And, in doing that, it must exceed it by a factor of at least 1:2.

That means that for a particular risk, the trader sets the take profit (a.k.a. reward) at least two times the risk. Obviously, the higher the ratio, the better for the trading account.

But the idea is to minimize both the costs and the risks. And, when looking at how many currency pairs are available on the Forex dashboard, traders favor lower risk-reward ratios but frequent trades, than higher ones but rare trades.

The reaction is normal and doesn’t come from greed. Instead, it comes from the fear of missing out a trade.

When waiting for a risk-reward ratio of 1:10, for instance, the setup doesn’t come often. It may happen once a quarter or so. Hence, missing it ruins the trading plan for three months or so.

To avoid that, traders settle for smaller risk-reward ratios but frequent trades. The idea of 1:2 implies that traders can afford to win every other two trades and still not lose money.

By the time a trader thinks of finding the right risk-reward ratio according to his/her strategy and personality, he/she is no longer a rookie trader. Instead, plenty of experience exists, with some years in front of the Forex charts, wondering how to make this work best.

Increase the Chances to Survive

Trading is a game of probabilities. That’s no secret in that.

What traders look for is the highest-probability setup with the smallest risk possible. But this approach has a problem: how to define the risk, so that it is the least possible amount?

One thing is clear: we can’t use pips. In Forex trading, setting a stop loss of about ten or fifty pips won’t get you anywhere.

Distances aren’t traveled the same on all pairs. For instance, on the EURUSD pair, fifty pips are something. However, on the EURAUD, such a distance is traveled very fast. Hence, one size fits all doesn’t work here.

Whenever facing such a problem, the solution comes from percentages. Using percentages helps when dealing with different market environments.

In Forex trading, every currency pair is a market on its own. Moreover, it has different daily ranges; it reacts differently to economic news, liquidity differs too, and so on.

Therefore, a percentage works best when setting the risk for a trade. More precisely, one percent does the trick.

As we’ve covered this already in one of the previous articles part of this Trading Academy, this is the time for you to do the math. Just open an Excel spreadsheet available on just about every Personal Computer (PC) these days.

Set the risk for a trade at one percent for every trade and run some math on it. You’ll find out that even after seventy-two consecutive losing trades, the account is down only fifty-percent.

But again, with a seventy-two percent consecutive losing trades, something must be wrong with the trading strategy, setup, mindset, etc. In any case, at least the trader has the chance to start all over again after a period of learning and to improve his/her trading abilities.

Now comes putting the risk-reward ratio into place. If any of the seventy-two losing trades ends up winning and respecting a 1:2 risk-reward ratio, the equity of the trading account will increase significantly.

Conclusion

Forex trading is not about the right trading setup. Moreover, trading is not about finding the holy grail in financial markets.

Instead, Forex trading is mostly about finding you as a person.

It might sound corny, but well, it is the truth. Knowing yourself as a person, with all the best and worst you can bring to the trading table prevents harming the trading account.

Risk-reward ratios do help. They belong to money management, and a simple Internet search can teach everyone how to set the right ratio to benefit the most.

However, reality tells that there’s much more needed than a simple risk-reward ratio. After all, we’re not robots.

As a trader, when you’re alone in front of your screens, the kids sleeping in the other room and you know you must make it this month, and the next one, and the following one, and so on…you’ll end up bending some rules.

Note the word “some.” And also note that this is not laming or blaming or anything like this.

Instead, it is the plain reality. Rules are made to be broken. Risk-reward ratios are made to be broken. Obviously, in the good sense, not the worse one.

Why not trying for 1:10 risk-reward ratios? Only because it is said in this article that such ratios are hard to find?

Markets change all the time, and trading conditions change daily. Forex trading changes because of the different everyday inputs.

One thing never changes, though: the will to succeed and the ability to that. That’s the secret to progress, and Forex trading is just another area where progress is easily spotted.