Overview of Risk Vs Reward | Risk – reward analysis for day trading

Do you want to know more about risk management, risk – reward analysis and what is the risk – reward ratio? Watch our latest video to find out how to effectively use the risk – reward ratio to get profitable trading results.

Risk – reward analysis – A simple but effective guide

In this video, I talk about risk versus reward. Without a doubt, this is one of the most basic money management fundamentals that you have to follow. The one thing that you have to understand about trading is that you are not going to win all of your trades. The reality is that you are going to have losses from time to time. By using risk to reward analysis, you can help increase the odds in your favor longer-term.

For example, if you’re risking 1 in order to make 5, you only need to be in order to break even. However, if you are risking 1 to make 1, you will likely lose money over the longer term as the losses will wipe out gains much quicker.

Looking at a few trades, you can see that the first one is a massive hammer that formed at the bottom of the downtrend. This is typically a reversal signal, but if you use classic technical analysis and trading technique, you can see that on the hammer you would have to risk something akin to 550 pips. Now looking at the trade itself, you have to ask yourself how far can this particular pair go? In this case, you can make a real argument for the 155 level, but the problem is that you’re working against the trend. Because of this, you have to take that into account, and you can also find quite a bit noise on this chart at the 153 level, meaning that you are more than likely going to get 250 pips. This is an absolutely horrible risk to reward ratio and therefore this isn’t the type of trade that you want to take as you would almost always have to be correct on these setups.

On the other hand, the next trade that I point out is a bearish candle that found resistance at an area of 164 that has been resistive time and time again. By entering at the bottom of the candle, you’re risking 400 pips, but the first target that I see would be the lows that we recently had, and therefore we are aiming for 600 while only risking 400. With that type of setup, you don’t have to be right as often, and it’s a little bit better set up.

As a zoom out and look at a trade from several months ago, there is a two-day reversal that sets up at the 175 region. So that’s where I would put my stop loss at the top of those 2 candles, and then would enter the market at the 172.25 level which is the bottom of those candles. By aiming for the most recent low which is a fairly reasonable assumption, you are aiming for 800 pips while only risking 275. Because of this, you only need to make roughly one out of 4 trades in order to break even at this point in time, which obviously makes trading much easier. Add in the fact that you are going with the trend, and the reality is you will probably get a couple of wins which puts you in the profit.