What is the optimum return-to-risk ratio in foreign exchange trading?

The trader's return/risk ratio is an important part of the trading plan. This ratio is not an arbitrary number, and you should not determine your return/risk ratio just by considering the profitable part.

Because this ratio can really make a difference in trading, we need to understand why it is so important for trading systems, and what are the advantages and disadvantages of increasing or decreasing the return/risk ratio.

What is the return/risk ratio?

In the transaction,Your return-to-risk ratio is determined by your profit target and the risk involved in each trade.For example, if your profit target is 100 points and your risk is 50 points, then your return/risk ratio is 2:1.

And if your profit goal is 100 points and your risk is 100 points, then your return/risk ratio is 1:1.

It is important to note that the return/risk ratio may not be consistent with your actual trading results. After all, trading results can be influenced by other factors, such as trailing stops and early closures.

The importance of the return/risk ratio

Assuming the return-to-risk ratio is 1:1 and the profit margin is 50%, you could end up losing money after deducting spread fees, commissions, and other operating expenses.

However, if your return/risk ratio is 2:1 and your profit margin is 50%, then you are much more profitable. Without accounting for various transaction fees, even if the profit margin is only 35%, you will still be profitable in the end.

Of course, in the real world, depending on the trading system, it is not possible for every profitable trade to achieve your goals. For example, you may need to exit early to retain a portion of your profits before major news is released.

As you can see from the chart above, the higher the return/risk ratio, the fewer trades are required to reach the profit target. So why not just set the return/risk ratio to 10:1 once and for all?

The advantages and disadvantages of adjusting the return/risk ratio

As mentioned above, the higher the return/risk ratio, the fewer trades you can make. This is one of the obvious advantages. However, the higher your profit target, the less likely you are to reach it:

We set the entry point in the bullish candle swallowing pattern above, and the stop loss is set according to the standard position. It can be seen that the return/risk ratios of 1:1 and 2:1 are actually relatively easy to achieve, and it is even possible to reach 3:1 before the first resistance level.

However, the market hardly ever reaches a 4:1 level, let alone a 5:1 level. And the chart above is itself a special case of a bull market correction trend, as most of these trades are actually less than a 3:1 return/risk ratio.

The best return/risk ratio in trading

Depending on the system and trading strategy traders use, the return/risk ratio also varies widely. For example, a scalp trader may make a profit of 1 point per trade, so his return/risk ratio is not even 2:1. Many traders most often use a 2:1 return/risk ratio. In the chart below, two bear market gestation patterns are followed by bull market gestation patterns:

For me, it is necessary to have at least a 3:1 return/risk ratio in gestation patterns, because they are not strong patterns, and gestation patterns usually lead to good return/risk ratio scenarios. As you can see from the chart above, a 3:1 return/risk ratio is completely achievable. This pattern can sometimes generate more profits than a small correction.

It should be said that a 2:1 or 3:1 return/risk ratio in a transaction is more appropriate.

Scalping traders usually choose a ratio of 1:1 or even lower, because what matters most to them is not high return/risk, but profitability. Position traders can have a return/risk ratio as high as 10:1, because their positions need to wait for long-term fundamental or technical conditions to trigger.

Overall, the specific situation still has to be determined according to each trader's system and strategy.