There’s one big reason why I like multiple timeframe trading and it is to do with the trading risk reward ratio.
In this post, I will explain how the risk:reward ratio gets impacted by the stop loss size, especially if you are placing stop loss based on market conditions.
Furthermore, this stop loss size is also a factor of the timeframe you execute your trade in.
DEFINITION OF RISK REWARD RATIO IN FOREX TRADING
If you don’t know what the risk:reward ratio is then here is bit of an explanation.
One of the biggest foundations of forex trading success is the knowing what the risk:reward ratio is and applying in live forex trading.
In simple terms, the risk:reward ratio is a measure of how much you are risking in a trade for what amount of profit.
For example, if you risked $500 in a trade and the profit you got was $1500 then $500:$1500=1:3, which simply means that your risk to reward ratio was 1:3.
This also means that for every $1 you risk, you have the “potential” make $3 profit.
WHY IS TRADING RISK:REWARD RATIO IMPORTANT in Forex Trading?
Risk:reward ratio is important in forex trading because of one thing only: you want to make more profits that what you are risking.
In that way, no matter the trading loses that you suffer, because of your risk:reward, you’d always get ahead.
Lets go back to the previous example: You place a trade and risk $500 initially and your take profit target is $1500.
Lets assume that that is your first trade and you made a profit on that trade-$1500. Sweet!
Now, you placed a second trade, and you made another $1,500 profit. Great!
Now you placed a third trade, you made a loss of $500. Oh!
Now you placed a 4th trade, you made a loss of $500! Ouch!
But then look at your figures, you are down $1000 in your forex trading account, right? How much did you make in your first trade? $1,500.
So the profits of the first trade are “cushioning” your $1000 trading loss. You still have $500 profit leftover from that first trade. The 2nd Trade’s profit is still untouched/intact!
This example shows you the beauty of having risk:reward trading ratio 1:3 and above-you can suffer 20 trading loses in a row but if you stick to your risk:reward ratio, you have a lot more chance of coming out in the front again when you start having some wins.
As as you can see from the example, you are not going to need a lot of wins to be back in the front.
So here are the benefits of having risk:reward ratio 1:3 and above:
- it allows you to have many losing trades…What? Yes, you read that one right. That kind of risk:reward allows you to have a lot of losing trades assuming that your trading risked is fixed on each trade but these losing trades do not significantly impact your forex trading account negatively.
- it allows you to have a few winning trades to accelerate you to get in the front again.
How Trading In Larger Timeframes Can Decrease Your Risk:Reward Ratio
Risk:reward is dependent upon the stop loss size.
- if you trade using smaller timeframes under 1 hour, your stop loss sizes are going to be small.
- If you trade the 4 hour timeframes and up, you stop loss sizes are going to be a lot bigger.
Where you set your take profit target ultimately determines your risk:reward situation.
In this example, we will assume that 3 different traders took a buy trade on USDCHF based on the same trading setup. All 3 traders saw this buy trade setup forming in the daily timeframe but each took a different approach to trading that setup:
- Trader A, traded based on the daily timeframe.
- Trade B, traded based on the 4hr time frame
- Trader C traded based on the 1h timeframe.
- All 3 traders had their stop loss orders placed at the same price level.
- All 3 traders aslo had their take profit targets set on the same level which was hit making them different profits.
Here’s Traders A’s Trade who traded using the Daily Timeframe and also his risk:reward result:
This is Trade B’s Trade and also his risk:reward outcome:
Here is trader C’s trade and his risk:reward outcome:
Remember! All 3 trades traded the same setup using different timeframes.
The result? Different risk:reward.
Here’s the summary:
Trader A daily timeframe: risk:reward=1:2
Trade B, 4hr timeframe:risk:reward=1:4.44
Trader C, 1 hr timeframe, risk:reward: 1:10
Who Are The Multiple Timeframe Traders In This Example?
Traders B & C. They both saw this trading setup in the daily timeframe but they DID NOT trade that setup in the daily timeframe but switched to a lower timeframe to wait to buy.
And since both of these traders did that, their risk:reward outcome was a lot better than that of Trader A.
But in comparison between Trader B & C, Trader C was the overall winner in this trade.
Now, what if each of these three traders traded 1 standard contract each? (Lets assume that 1 pips is $10)
Well, trader A gets a $2,226 in profit
Trader B gets $2,800 in profit
Trade C gets $3,110 in profit.
But Wait There’s More…
Lets assume that each of these 3 traders had a $25,000 live trading account.
And based on this example:
- Trader A risked $1170(117 pips) to make $2,226. That was a 4.7 % trading risk.
- Trader B risked $630 (63 pips) to make $2,800 profit, his % risk was 2.5%.
- Trader C risked $320 (32 pips), to make $3,110 profit, his trading risk was 1.3%
For the sake of this example, lets assume that each trader trades using a 5% risk per trade.
Now, this fact alone changes a few things:
- the number of contracts traded will be different based on the risk
- therefore, the profits each get will also change.
Ok, let’s play a different scenario with the figures to see how many contracts each trader is going to trade with a 5% trading account risk:
- Trader A can only risk $1,250 to keep his trading risk at 5%. His stop loss is 117 pips. Therefore the amount of contracts he can trade is 1.06 contracts. He decided to make it a whole number and only trades 1 contract. His profit would be still the same @ $2,260.
- Similarly, Trader B can only risk $1,250 to keep his trading risk at 5%. But his stop loss is 63 pips ($630 risk). Therefore the amount of contracts he can trade is 1.98 contracts. He decides to only trade 1.9 contracts.
- Now, Trader C also has $1,250 which is 5% of his account. His stop loss is only 32 pips ($320) risk. This means he can trade 3.9 contracts…and he decides to stick to trading 3.9 contracts.
What do their final profit figures look like?
Trader A Trades 1 contract, Profit was 226 pips=>226 pips x $10.pip x 1 contract=$2,260
Trader B Trades 1.9 Contracts, Profit was 280 pips=>280 pips x $10/pip x 1.9 contracts=$5,320
Trader C Trades 3.9 contracts, his profit in the trade was 311 pips=>311 pips x $10/pip x 3.9 contracts=$12,129
Its Not Over Yet…
You can have the same trading account size and apply the same risk percentage to your trading account and take the same trading setups but the trader who gets in at the best possible price just before the market turns stands to make the most money because he keeps his stop loss size small whilst aiming for bigger wins.
In short, the trader with the best risk:reward ratio wins BIG.
Now if you are just thinking of the profits that Trader C made, you are missing the whole point here.
Look at the account growth for each trader after.
- Trader C made $12,129 Dollars in Profits from that one trade by just risking 5% of his trading account.That an impressive 48.5% trading account increase.
- Trader B increased his trading account by 21.2%.
- Trade A increased his account by 8.9% only.
Why the big difference between each trader?
Risk:Reward, that’s why!
Now, for some of you reading this, it is not something new. You’ve probably read about his, know how it works and that’s good because this article is just a refresher to give you a lot more appreciation of how risk:reward affects your trading outcome.
The examples I’ve shown you are based on my own experiences trading forex and I can tell you for a fact that the proper application of risk:reward can increase your trading account fast (you are not risking more!) in a short period of time.
I’ve applied this technique on many trades and I know it works. I did not pluck this article out of thin air to write about something that I did not know about or experienced it myself.
Let me go over the main points:
- Multiple Timeframe Trading is the key here. You need to understand it and know how to apply it.
- Know your reversal candlesticks, they give you really good clues as to where to place your pending orders etc as well as giving your ideal locations to place your stop loss so that you do not get stopped out prematurely.
- trading in larger timeframes give you large stop loss distance which effectively reduces your risk:reward outcome. The benefit of trading in larger timeframe is that you tend to avoid the “noise” that happen in smaller timeframes.
- smaller timeframe trading using multiple timeframe trading allows you to get in with a “tight” stop loss and aiming for big reward.
I use this techniques given here to increase my trading accounts fast in a short periods of time and then blow them up fast because I got GREEDY as I have explained here.
You wan’t to be more successful that me, do the exact opposite of what I do!
Hope you liked this article. As usual, I’m going to ask you to share, like, tweet etc if you enjoyed it. Take care!
Again for me, another article that will help me tremendously in my trading. Your writing style is clear and informative and packed with examples and charts which helps make things more clear (for me). After reading this article, I evaluated a couple of my recent trades, and my risks, in some cases, were greater than my potential reward. Hmm, not good so I will change this immediately thanks to this article and many others on your site. Thanks again.