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Chapter 33, Part I. Risk Management Framework. Page 10

Discussion in 'Complete Trading Education- Forex Military School' started by Sive Morten, Dec 28, 2013.

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  1. Sive Morten

    Sive Morten Special Consultant to the FPA

    Aug 28, 2009
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    We recommend dealing with it as follows. Make your analysis of the market and estimate crucial levels for your scenario. Let’s suppose you intend to enter Long on EUR/USD from 1.3520 level on hourly chart and you have estimated that if market will break down 1.3470 area – this will significantly increase the probability of downward acceleration and your bullish scenario will have vanished. So, your crucial level is 1.3470 + some room. Hence, you will place stop somewhere around 1.3450 probably. Your risk is 80 pips.

    Now estimate your target. Let’s suppose that nearest 0.618 target of some AB-CD extension stands at 1.3590 and initially you intend to take it. Here is your reward risk ratio is 7:8<1, and probably you have to reject this trade as ineffective.

    If market will show some deeper retracement and your context for a long trade will still hold, say to 1.3490, then you can try it, because now you will have 100:40=2.5>1 reward/risk ratio.

    The major mistake that many traders do with reward/risk calculation is force it to context, or force orders’ placement to reach a ratio greater than 1.
    This is quite unwise. Reward/risk ratio is a statistical measure but not a tool that brings you money. You may reach a ratio>1 by artificially placing orders, take bad trades and lose money – will it be nice, will you be happy that you at least had ratio>1? I don’t think so. This ratio is a tool, but not a goal to achieve. It lets you escape unwelcome trades. So use it accordingly. Besides, acting like this you break your trading system and do not follow the trading plan – one mistake triggers others.

    P.S. This lesson was written by Sive Morten, who has been working for a large European Bank since April of 2000, and is currently a supervisor of the bank's risk assessment department. Sive's knowledge of forex market and banking industry is vast and quite complete. If you have any specific questions about forex, banking industry, or any other financial instruments, please post them on the next page and Sive should answer soon.

    Note: FPA ranks are earned in the battles against scam, not in the classroom.
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