Understanding a Risk-Reward Ratio
In this video, we cover how to calculate risk and reward ratios when you’re trading on the Plus500 platform. Risk-reward ratios can help you to determine your expected profit when you open a position as compared to the amount of the position’s expected risk.
Traders frequently choose risk-reward ratios that fall in a range from 1:2 to 1:4, meaning that for every dollar that you risk in a trade, you could expect to receive between two and four dollars back.
The amount of risk that you are willing to assume is a personal choice that could affect your potential returns. For example, taking on more risk could result in higher profits or bigger losses.
Let’s look at an example. Say that you wanted to open a buy position in 10 Meta shares CFDs, and you believe that the price per share was likely to go up by $40 per share. If you were correct, this would result in a total profit of $400. With a risk-reward ratio of 1:4, you would want to risk no more than $100 on this trade, in case the trade went against you.
Using Stop-loss and Stop-limit orders together with risk-reward ratios
You can help maintain your desired risk-reward ratio by setting a stop-loss when you place an order. A stop-loss closes your position when its price reaches or surpasses a target that you decide upon, potentially keeping you from losing more than what you have decided is within your risk appetite.
You can also safeguard your targeted profitability by creating a close-at-profit (stop-limit) order when you open a position. This would close your position once your desired amount of reward is reached. Keep in mind that slippage could result in a position closing below your stop-loss or above your stop-limit.
Setting the right risk-reward ratio will depend upon your trading strategy and how much risk you are willing to take on. By maintaining your target risk-reward strategy across the positions in your portfolio, your potential gains will be greater than your potential losses. This could help you see a profit, even if you have losing positions.
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