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Strategy Video: A 2- to-1 Risk-Reward Ratio Doesn't Ensure a Good Trade

Strategy Video: A 2- to-1 Risk-Reward Ratio Doesn't Ensure a Good Trade

2014-12-09 04:30:00
John Kicklighter, Chief Strategist
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Talking Points:

• Establishing the risk-reward ratio for each trade and your strategy is critical risk management

• However, setting a high (or even moderate) risk-reward doesn't necessarily improve the trade's potential

• Risk-Reward should be considered a critical checklist item, but not a reason to justify a trade

Want to develop a more in-depth knowledge on the market and strategies? Check out the DailyFX Trading Guides we have produced on a range of topics.

A strong risk-reward ratio is an important aspect to every trade and is critical to our strategy in general. However, leveraging our targets and moving our stops closer does not improve the probability of our setups. Oftentimes a preferred risk-reward can substantially reduce the chances that our trade will end profitably - even when other aspects like the fundamentals, technicals and market conditions are all favorable. There are many instances where the probability and potential of trades can be rebalanced such that a 1:1 risk-reward is more reasonable (when the strategy has a higher percentage of winners), and sometimes it can be dramatically skewed (as with EURCHF and its unusual 1.2000-floor). We discuss why relying solely on risk-reward can be dangerous and how to incorporate it as a risk-management rule in a complete strategy in today's Strategy Video.

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