Position sizing involves making an objective decision about what positions to take when trading, and it makes risk reward ratio in forex trading an important part of just about any sound money management strategy. As a result, it would be a good idea for forex traders to incorporate some form or position sizing methodology into their trade plans. Furthermore, many successful traders routinely assess the risk reward ratio of a particular trade they are considering entering as part of their decision making process.
Some of them even incorporate criteria based on risk reward ratios into their trading plan. An additional application of risk reward ratios among forex traders is in performing position sizing. Such a technique usually increases the size of a position depending upon how successful the trade is anticipated to be. In general, a risk-reward ratio of 1:2 means that you would risk one pip of loss to potentially earn 2 pips. To provide a general guide, most successful traders will not enter a trade unless the risk they foresee for it is less than half of what their anticipated reward will be. Reward Ratio criterion for any trades they will consider entering.
Basically, having your risk be less than your potential reward on prospective trades is one of the recipes for successful money management over the long term when trading forex. Of course, once a trade is entered, any changes to the stop loss or take profit levels, perhaps using the technique of trailing stops will change the risk reward ratio of the position. In addition to assessing the risk reward ratio the trader is willing to assume before any trade, they may also take into account important technical analysis factors like the presence of nearby support and resistance levels. Most successful traders refuse to take on a position unless they can expect to at least make twice the original investment.
1:2, where they risk one unit to make two. They can also take on larger trades when a higher probability of success is anticipated, perhaps using the risk reward ratio as a criterion for doing so. As long as the risk taken on each still falls with acceptable risk taking parameters, then this can be a successful enhancement to a trading plan. Perhaps the easiest way to size positions based on the risk reward ratio would be to first compute the ratio, and then take positions only if it is better than say 1:2, for example.