In this week’s Wednesday Wisdom a TraderRach reader asks, when intra-day trading does it make sense to go for a reward at half my stop loss with a reward to risk ratio of 1:2, or should my profits be bigger than my losses? Thank you to Umair Usman for asking this question that many traders may be pondering.
Forex trading systems are so incredibly varied that there are no 100% right and wrong answers. I’ve seen some forex traders make a success of both small and large targets.
Here are 8 ideas to challenge your thinking to help you work out your forex trading take profit sweet spot.
1. Reduce the cost to trade to pay yourself earlier
There’s no escaping the impact of the cost to trade. The closer your profit target is to the entry, the greater the cost to trade.
The forex spread means that the smaller the number of pips to our profit target exit, the bigger is the cost to trade.
Review my article Play To Win The Forex Timeframe Game for a greater explanation.
The broker always get’s paid no matter what your outcome, good or bad. Some trading systems are more cost effective so that you have a lower cost hurdle to overcome before you make money.
The closer the take profit target is, the greater is the edge required for your underlying forex trading system to remain profitable after a more significant cost to trade. Lower rewards to risk systems make the profitability formula harder to achieve.
2. Searching the sweet spot through testing
Market behavior changes over time and so does the market state.
Back testing past data and forward testing live can help a forex trader work out if there’s a take profit sweet spot. We can go searching for a place where available data tells us where an exit is more likely to produce a profitable system.
It can also help us understand the conditions when a take profit scenario works and when it doesn’t.
More information on market state can be found in the article Forex Market State – Are We Off Having A Snooze?
3. Feeling good through regular winning
The closer our take profit, the more often we win. It’s an obvious fact because the profit target is closer, so price doesn’t have to move as far in our favour to win.
Having a higher win rate can make us feel better as we have more days worth celebrating. However it’s not a justification in itself for accepting low reward to risk trading scenarios.
We need to work through the desire to win often so that we trade with the big picture.
4. Review the effectiveness with your money management strategy
Your chosen money management strategy may perform very differently with a high win rate system versus a lower win rate system.
It’s what our performance is after applying our money management strategy that will determine how much money we make from our forex trading.
5. Consider your human side, your risk personality
How are you going to feel going for small wins while risking large losses? Will you feel confident putting the trades on even if the market has given you a hard time?
Can you handle the frequent losses of trading for relatively large wins, while 100% accepting the losses and placing the next trades?
We all have a level of risk tolerance, but over time with conditioning and practice, that can change.
There’s no point trading in a way that makes you freeze up and stop putting the trades on, but identify what’s best to achieve the results you want and move yourself and your forex trading along a journey to achieve it.
6. Beware of head butting the “cut losses short and let profits run” rule
Taking low win rate trades goes against the long held view common among traders to cut losses short and let profits run.
There will be times when the market makes short moves and then falls away. There will be others where the market takes off and never looks back.
A low reward to risk system will not capitalise on large consistent trending moves unless there’s a method for re-entry.
Will your forex trading take you forward positively without large winning trades in the mix?
7. Are the odds in your favour where probability is concerned?
When we enter a forex trade it’s good to know that the odds are in your favour. Or are they?
For example, it feels like a good risk to take if you were risking an amount with the possibility of making three times that. But is this logic correct?
Is it bad risk to risk an amount with the probability of losing the lot or making half the amount we risked?
Is our logic about good and bad risk right or wrong?
Take the scenario of a lotto ticket. We have the chance to be millionaires when we buy the ticket. Our dreams go wild and we start visualizing the good life.
Having a good potential payoff on an individual trade does not make a risk good. Where lotto is concerned the odds are so low that we could take tickets each week for our whole lives and be left with nothing but a big hole in our pocket.
Whether the odds are in our favour is much more than the reward to risk proposition of a forex trade. Will lower or higher reward to risk options provide better odds of having a profitable system?
8. Average profits and losses can be variable where the market decides
Remember that average losses and average profits don’t need to come entirely from hitting originally set stop loss and profit targets. As a forex trade progresses there’s always the option to progressively move these levels in response to market price action.
Set and forget forex trading can be liberating but trade outcomes may come in a variety of ways.
Consider whether you’re better off letting the market decide what your average loss and average win is by using systematically responsive exits, or sticking with set and forex style forex trading.
The most suitable option depends on your objectives, temperament and your forex trading system.
Personalising your forex reward to risk outcomes
Do your own analysis for your unique situation and find the reward to risk proposition that works as part of your complete suite of choices.
It’s ultimately you who will need the confidence and understanding to trade your forex trading system(s) to profitable outcomes.
There’s no one way or the highway. You may trade many forex trading styles concurrently to success.
Think smart to be smart and consider your options. Challenge your thinking with the 8 forex trading ideas presented here to help you achieve mastery.
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About the Author: I’m Rachel Hunter, TraderRach, a Forex Trader who helps traders achieve the life they love with forex. Be strategic and design your trading business for sustainable success and have fun! That’s my mission. Join many traders’ gaining the edge with “10 Powerful Lessons for Forex Trading Success” plus other goodies. Years of precious learning specially packaged up for you. My background before trading is as a Chartered Accountant and Chief Financial Officer. I know what it takes to make a trading business rock on. It would give me great pleasure to make a difference to your success.