How traders view risk and reward with retail FX brokers
Traders share their risk and reward questions, an area of retail trading that often is not discussed at broker level.
Risk and reward is very much a two way tug of war in the mind of the retail trader.
Often, brokerages are not privy to the risk and reward approach taken by traders, as this does not usually form much of the dialog between brokers and their clients.
More often, trading conditions, commission, whether trades are warehoused or executed with the prime brokerage are topics of conversation between brokers and traders, however today, FinanceFeeds spoke to a series of retail traders who discussed their attitude toward risk and reward when working closely with retail brokers.
“To increase your chances of profitability, you want to trade when you have the potential to make 3 times more than you are risking. If you give yourself a 3:1 reward-to-risk ratio, you have a significantly greater chance of ending up profitable in the long run” said a trader based in Manchester, England.
On the very surface, the concept of putting a high reward-to-risk ratio sounds good, but think about how it applies in actual trade scenarios.
If, for example, a trader is a scalper and only wishes to risk 3 pips. Using a 3:1 reward to risk ratio, this means you need to get 9 pips. Right off the bat, the odds are against you because you have to pay the spread.
If a broker offered a 2 pip spread on EUR/USD, then a trader will have to gain 11 pips instead, forcing the trader to take a difficult 4:1 reward to risk ratio.
Considering the exchange rate of EUR/USD could move 3 pips up and down within a few seconds, a trader would be stopped out very quickly.
These are factors which are rarely considered by less than highly experienced traders, and perhaps should be part of brokerage support toward traders.
“Let’s say someone says his risk:reward ratio is 1:4. Does that mean the spreads he pays when he enters and exits his trades are part of the “risk”? Or is the risk purely the distance between the entry price and the SL price?” asked a trader today.
A trader from Germany replied “To me it’s always the distance between the entry price and where the trade was closed divided by the distance between the entry price (which already includes the spread) and the stop loss. For example, the reward of 50 pips divided by 10 pips (the distance between SL and entry price) lives us with the R:R of 5”.
“I count the risk percentage on the amount I am entering the trade. So if I have to rollover a trade I am still within my “loss boundaries” if I were to lose that trade. If I win, great but it’s about being in control of your losses” said another retail trader.
If you were to reduce your position size, then you could widen your stop to maintain your desired reward/risk ratio.
Now, if you increased the pips you wanted to risk to 50, you would need to gain 153 pips.
By doing this, you are able to bring your reward-to-risk ratio somewhere nearer to your desired 3:1. Not so bad anymore, right?
In the real world, reward-to-risk ratios aren’t set in stone. They must be adjusted depending on the time frame, trading environment, and your entry/exit points.
A position trade could have a reward-to-risk ratio as high as 10:1 while a scalper could go for as little as 0.7:1.