The story goes…
Historically, traders have a rule that a stop loss should be no more than a taking of earnings. There is a logic in this, if you receive more losses than profits, sooner or later your account will disappear.
But time passes and the market is changing and today it does not seem so ideal.
Every trader must understand that after a large number of trades, the expectation must be positive.
The expectation formula is as follows:
(Average profit value * ratio of profitable positions) – (average loss value * ratio of unprofitable positions) – transaction costs.
In order not to bother with calculations, traders have created a table that shows simply and clear what is a positive expectation
According to the table, if only 20% of the total number of their trades are profitable, then the RISK/GAIN ratio should be 5:1 and above.
If there are 50% profitable trades, then the ratio can be 2:1, and if there are 60% profitable trades, the stop loss can be even higher than the take profit.
Therefore, the main rule for a trader to follow is that the lower the taking profit, the higher the profit rate.
The difference in the markets
It’s worth remembering that 80% of the books from which this risk-reward advice comes are written about the stock market, which is more inclined to go up than down.
On the other hand, currency pairs tend to average.
This is the main difference: in the forex market, if the stop is large, you can avoid fluctuations, if the taking it’s great, can’t wait for it to work.
You must understand when and where to use a large taking of gains and a limitation of losses depending on the strategy and the market.
And not because you have multiplied the stop loss by 10.
The conclusion may be unexpected, but the benefit/risk ratio is not an unbreakable rule.
Always adhere to the positive expectation rule.
Set a stop loss and a taking of profits depending on the strategy and the market in which you are operating.