Excellent Risk/Reward Ratio with Wider Stop-Loss

Excellent Risk/Reward Ratio with Wider Stop-Loss

Submitted by adil on Mon, 03/30/2015 - 07:33

Many traders believe that a tight stop-loss is required to have a good risk/reward ratio which is correct. For example, if you risk 20 pips to gain 200 pips, your risk/reward ratio is 10:1 but if you risk the same amount for 100 pips, your risk/reward will fall to 5:1. Hence, the tighter the stop-loss, the better is the risk/reward.

But there is another method through which you can made wider stop-loss but still gain high risk/reward ratio.

Many traders are overly-obsessed with being right in their trade entry level, but this obsession comes from a tight stop-loss. When you come to think of it, having a tighter stop-loss, you are required to be very accurate before you get into the trade otherwise you will be stopped out.

Now, as you can see, most of your energy is being consumed in the effort of being right. Would not it be a relief if you could enter trades without having to be right all the time? Actually, you can if you make wide stop-loss through a simple procedure. In my experience, there are more winners in this case because once your mind is liberated from the need of always being right, you can make better trade.

Also, as your trades go up, you can make larger positions with this method and hence more profits.

This process is relatively simpler with no fancy techniques. It is helpful in the sense that you can turn a possible risk/reward of 3:1 into a 10:1 or ever higher ratio without any extra risk but just a wider stop-loss. This is applicable to long term trades and short term trades as well. In short term trades, the stop-loss has to be relatively wider.

Let’s use an example to understand how the method works. This is a long term trade on the EUR/USD. The trade initially generated a risk/reward ratio of 3.3:1 to get 1000 pips with a 300 pip stop-loss. But let us see how this ratio was made 15 times better with a wider stop-loss.

First of all you need a good entry. When you get entry signal, make normal initial positions but triple the stop-loss than your normal amount. You might also need a trade catalyst.

Add a new trade position. Give another 100-150 pips to the additional position. Now combine the stops and move them up together. In this way you will not risk any more than your original amount of money. If you had profits from the first position, you will be able to make wider stop. Now set a new target for 1000 pips on the new position, the amount of risk is same in this position but you can make an additional 3.3 on the trade. Now your risk/reward is 6.6:1

It is better to have multiple profit targets here. You can keep adding more positions to such a trade. Each additional position will improve your risk/reward without increasing the original maximum risk of your account. This can also be called trade implementation. You are not simply entering a trade; you are anticipating its moves and increasing your reward without doubling risk.This approach is not always so easy, hence it is better to learn and practice for good results.