Most Forex tutorials will tell you that your risk-to-reward ratio should be at least 1:2. This has been mentioned many times in our blog as well. However, many traders today make their stop a few times larger than their take profit. Why is this happening and is it worth using this approach?
Expectation
The risk-to-reward ratio may vary depending on the percentage of your winning trades. The higher it is, the smaller the ratio might be. And at some point, the stop loss may exceed your take profit:
- Only 20% of profitable trades require a minimum risk-to-reward ratio of 1:5.
- If half of your trades are profitable, the ratio can be reduced to 1:2.
- If the number of profitable trades exceeds 60%, then the stop loss might exceed the take profit. Yet, the overall result will remain positive.
Market Features
Most of the sources that state that take profit must exceed stop loss describe trading in the US stock market. In this market, the uptrend prevails over the downtrend. The foreign exchange market is prone to averaging:
- If you look at a stock chart over several years, except for a few fluctuations, the price will gradually move up.
- The cost of most currencies in Forex fluctuates within a certain range for several years and constantly returns to the average level.
Due to this peculiarity of the currency market, a large stop can help to sit out the drawdowns, while a too large take profit might not even work out.
Which Tactic to Choose?
Forex trading is an inexact science. The same can be said in this situation. There is no exact answer on which strategy to proceed with. It is necessary to analyze the current situation on the market and set the appropriate exit levels:
- If at the moment the market is inclined to a significant increase, you can safely set a take profit away from the entry point.
- Frequent fluctuations in both directions with a general upward trend might suggest that it is better to widen the stop loss in order to sit out drawdowns.
With experience, traders start to understand how the market works on an intuitive level. If something tells you that the stop should be widened and the take profit should be reduced, then you should do so. However, it is better to do this when the number of your profitable trades has already exceeded 60%. When choosing exit points, take into account your trading strategy, risk management system, the results of technical and/or fundamental analysis and the characteristics of the market you trade.
If you are a novice trader, then it is better to keep the risk-to-reward ratio at least 1:2.