Time Cell Trading

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Five Key Factors that Move the Forex Markets -- and How to Profit from Them

Key Factor 2. Economic Growth.
The next factor you need to consider when predicting a country's currency movements is its economic growth. The stronger the economy, the greater the possibility that the central bank will raise its interest rates to tame the growth of inflation. And the higher a country's interest rates, the bigger the likelihood that foreign investors will invest in a country's financial markets. More foreign investors means a greater demand for the country's currency. A greater demand results in an increase in a currency's value.

Hence, a ripple effect: economic growth inspires higher interest rates inspires more foreign investment inspires greater currency demand which inspires an increase in the currency's value.

How Anemic Economic Growth Crashed EUR/USD 2,000 Points
For a good example of the impact of economic growth on the direction of currency rates, let’s look at the EUR/USD from 2005 to 2006. Economic growth is best measured by a country's Gross Domestic Product, or GDP. The United States and Eurozone represent two of the most prosperous regions in the world with GDPs running at $13 trillion and $11 trillion respectively.


In 2005 and 2006, the difference in growth rates between the two major economic powers was clearly reflected in currency movements. In 2005, the Eurozone lagged significantly behind the United States in economic growth, averaging an anemic 1.5% rate throughout the year while the US expanded at a healthy 3% rate. Consequently, investment capital flowed from Europe to the US and the EUR/USD dropped by nearly 2,000 basis points by the end of 2005. In 2006, however, Eurozone growth perked up while US growth began to slow. At the end of 2006, Eurozone GDP actually overtook US growth rates, causing the EUR/USD to rally.

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In 2005, The EUR/USD plummeted as Eurozone showed little economic growth compared to the US GDP. In 2006, as the EZ GDP rallied, so did the EUR/USD.

We've used GDP's to forecast trends on several more Forex trades in the past. One great example is our November 14, 2006, United States dollar/ Japanese yen trade (USD/JPY).

67 Points in Four Hours
In the middle of November 2006, hurt by the contraction in its housing sector, the US economic data began to deteriorate. Rumor had it that the US might lower interest rates in the first quarter of 2007, which would encourage foreign investors to look elsewhere.
Meanwhile, the Japanese economy was buoyed by the weak yen that made Japanese products affordable internationally and helped spur double digit growth in exports. On November 14, 2006, the Japanese GDP printed at much better than expected -- 2% versus the 1% forecast. We decided to take advantage of the strength of the Japanese economic growth vs. the relatively weak economic outlook in the US, so we went short USD/JPY at 117.82. As we hoped, that morning, in sharp contrast to Japan, US retail sales produced very weak numbers and the USD/JPY pair collapsed. We were able to collect 67 points on the trade in less than four hours.

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United States dollar vs. Japanese yen, November 14, 2006. The strong economic growth in Japan made the USD/JPY trade a success for us in November.

Next > Discover How Geo-Politics Influence Forex Trades

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Five Key Factors that Move the Forex Markets -- and How to Profit from Them

Key Factor 3. Geo-Politics.
Do you hate the business section? Do your eyes glaze over at the mere mention of economic data and mind-numbing accounting numbers? Fear not. The currency market is the only market in the world that can be successfully traded on political news as well as economic releases. Because currencies represent countries rather than companies, they are political as well as economic assets and are therefore very responsive to any disturbance in the political landscape.
The key to understanding speculative behavior with respect to any geopolitical unrest is that speculators run first and ask questions later. In other words, whenever investors fear any threat to their capital, they will quickly retreat to the sidelines until they are certain that the political risk has disappeared. Therefore, the general rule of thumb in the currency market is that politics almost always trumps economics. The history of FX is littered with examples of political trades. Let’s take a look at some examples over the past few years.

No-Confidence Vote Depresses LoonieThe end of May 2005 was not a happy time for the Liberal Party government of Canada’s Prime Minister, Paul Martin. After having guided the country to its best economic performance in 30 years, Martin was facing the fight of his life as his party prepared for a no-confidence vote stemming from accusations of past Liberal Party corruption.
Meanwhile, Canada’s economy was becoming a star performer, spurred by the massive rises in the price of oil. As the number one exporter of crude to the US, Canada was benefiting mightily from this newfound wealth. Yet despite the great economic news, the Canadian dollar remained weak against the greenback as traders worried about the implications of the fall of the Liberals.
On May 26, 2005, Martin’s government survived the no-confidence vote and the Canadian dollar rallied, causing the USD/CAD* to plunge 200 points in less than a week as the market once again focused on Canada’s stellar economic fundamentals.
*The USD/CAD pair trades inversely.

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Despite strong economic performance, the Canadian dollar remained weak until Martin survived the no-confidence vote and the Canadian political climate settled.

BoJ Governor Fukui Responsible for Floundering YenAt the beginning of June 2006, Bank of Japan Governor Fukui revealed to the Diet that he had invested 10 million yen in 1999 in a fund founded by financier Yoshiaki Murakami. Murakami was later indicted on charges of insider trading and although Fukui was not involved in any illegal activity, the mere appearance of impropriety in image-conscious Japan greatly damaged his reputation.


As the principal of Japan’s monetary policy during its recovery from a decade-long battle with deflation, Fukui was considered one of the most powerful men in the currency markets. His forced resignation would do great damage to the prospects of further recovery in Japan.
Meanwhile, Japanese economic data continued to show stellar economic performance as exports and business investment continued to grow, unemployment reached decade-long lows, and consumer sentiment improved. Talk spread through the markets that Japan would soon abandon its zero-interest rate policy and would actually have positive interest rates for the first time this century.
Despite all the positive speculation, the yen floundered, continuing to decline against the dollar as traders feared that Fukui would have to step down. Fukui stolidly refused, and as the furor passed and the market realized that he would stay on, the yen’s strength returned, showing once again that when it comes to currencies, politics can often be more important than economics.

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Despite positive speculation and strong economic reports, the Japanese yen did not regain strength until investors realized that Fukui would not resign.

If you enjoy predicting changes to the political landscape, your talents could be well utilized as a Forex trader. Recently, we predicted a strengthening of the Canadian dollar and earned close to 70 points in less than 24 hours. At 10 to 1 leverage you could have profited along with us, making a 7% return or $700 on a $10,000 trade.

How OPEC Made Us 70 Points

Geopolitical risk can mean wars, terrorist attacks, or missile launches, but it can also relate to milder yet still politically powerful events such as G7 meetings and OPEC announcements. In October 2006, Saudi Arabia announced that they would back OPEC’s plans to cut oil production by one million barrels a day after oil prices dropped more than 10% in just seven trading days. The cuts were to take effect on November 1, 2006, with more to come in December.

As Canada is a major exporter and producer of oil, we believed that this policy change would be very positive for the Canadian dollar. Therefore we went short the US dollar and long the Canadian on October 19, 2006. Over the next 24 hours, based upon the geopolitical theme, we earned close to 70 points on the trade.

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United States dollar vs. Canadian dollar, October 19, 2006. Knowing that OPEC's announcement would affect Canadian currency allowed us to gain 70 points on October 19.

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Next > How Trade and Capital Flows Influence Forex

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Five Key Factors that Move the Forex Markets -- and How to Profit from Them

Key Factor 4. Trade and Capital Flows
Before you make your final prediction about the trend of a country's currency, you should take a moment to categorize the country as dependent on either trade flow or capital flow. Trade flow refers to how much income a country earns through trade. Capital flow refers to how much investment a country attracts from abroad. Some countries are sensitive to trade flows, while others are far more dependent on capital flows.

Countries whose currency strength depends on their trade flows include:

 

1. Canada
2. Australia
3. New Zealand
4. Japan
5. Germany

These countries achieve a large portion of their growth through the export of various commodities. In the case of Canada, oil is the primary source of revenue. For Australia, industrial and precious metals dominate trade, and in New Zealand, agricultural goods are a crucial source of income. Trade flows are also important for other export-dependent countries such as Japan and Germany.


For countries such as the US and UK, which have large liquid investment markets, capital flows are of far greater importance. In these countries, financial services are paramount. In fact, in the US, financial services represented 40% of the total profits of the S&P 500.
The United States also serves as a perfect example of why it is crucial to understand which flows affect which country in order to effectively analyze the direction of currencies. On the surface, the US currency, with its record multi-billion dollar trade deficit and near $1 trillion current account deficit should depreciate significantly. However, that has not been the case. As the chart below illustrates, the US has been able to attract more than enough surplus capital from the rest of the world to offset the negative effects of its massive trade deficits.

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The US has massive trade deficits. However, its currency remains strong because it consistently attracts large amounts of investment capital (capital flow).

For the time being, trade-flow deficits do not matter to the dollar. However, should the US become unable to attract enough capital flow to offset its deficits, the currency may weaken.
Understanding the influence of trade and capital flows has been important to a number of our trades, including our New Zealand dollar/United States dollar (NZD/USD) trade on January 22, 2007.

Uridashi Bond Prediction Returns 40 Pips
New Zealand has one of the highest interest rates in the developed world (as of January 2007 it was 7.25%), and because of that fact, it is a major destination for capital flow. On January 22, 2007, there was talk of Uridashi bonds being issued to the benefit of the NZD. Uridashi bonds are issued when companies want to denominate their debt in a higher yielding currency and then offer it to Japanese investors. These are popular because the yield offered is far higher than the yield that Japanese investors can earn at home, which is less than 1%.
We anticipated that the week’s Uridashi issuances would inspire capital flow into New Zealand as investors purchased the bonds in New Zealand dollars. Once we made this prediction, we had to decide which New Zealand currency pair we would trade to best take advantage of the movement of the New Zealand dollar. We considered both the NZD/USD pair and the NZD/JPY.


We decided to go long the New Zealand dollar against the US dollar instead of against the Japanese yen. The risk/reward ratio to go long NZD/JPY versus NZD/USD was not as attractive. Our stop in the NZD/USD was more conservative than the risk we would have assumed in NZD/JPY. Therefore, we went long NZD/USD and banked 40 points over the next 24 hours.

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New Zealand dollar vs. United States dollar, January 22, 2007. We traded the New Zealand dollar / United States dollar on January 22. The trade returned 40 points in 24 hours.

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New Zealand dollar vs. Japanese yen, January 22, 2007. The New Zealand Dollar / Japanese yen trade would have been a higher risk than the above-charted NZD/USD trade.

Next > How Mergers and Acquisitions Drive Currency Prices

http://www.investopedia.com/forex/five-things-that-move-currency-market/free_report_pg6.aspx

Five Key Factors that Move the Forex Markets -- and How to Profit from Them

Key Factor 5. Mergers and Acquisitions
While merger and acquisition activity is the least important factor in determining the long-term direction of currencies, it can be the most powerful force in staging near-term currency moves. Merger and acquisition activity occurs when a company from one economic region wants to make a transnational transaction and buy a corporation from another country.
If, for example, a European company wants to buy a Canadian asset for $20 billion, it would have to go into the currency market and acquire the currency to affect this transaction. Typically, these deals are not price sensitive, but time sensitive because the acquirer may have a date by which the transaction is to be completed. Because of this underlying dynamic, merger and acquisition flow can exert a very strong temporary force on FX trading, sometimes skewing the natural course of currency flow for days or weeks.
If you keep abreast of international merger and acquisitions, you may be able to predict short-term fluctuations in FX. In late 2006, for example, Canadian economic data showed a great deal of weakness. Yet large demand for Canadian corporate assets from the Asia, Middle East, and Europe overrode the financial reports and kept the USD/CAD at all-time lows*.
*USD/CAD trades inversely

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Although economic data indicated USD/CAD should rally, the pair stayed at all-time lows due to a large number of foreign investors acquiring Canadian dollars to purchase Canadian equities.

In November of 2006, we made a healthy profit by predicting a backward acquisition effect: After a surprising government announcement, money that had been used to purchase equities in Canada, reversed flow and headed out of the country.

Canada Loses Investors, Inspires Big Forex Gains
Merger and acquisition activity can be a powerful but sometimes stealthy driver of demand in the currency market. When a country’s capital assets such as equities, suddenly find favor from the rest of the world, they indirectly affect pricing in the foreign exchange market as dealmakers first have to buy the country’s currency before they can buy the stock. However, woe unto any currency when this situation reverses. Such was the case with USD/CAD in November 2006.
In the fall of 2006, Stephen Harper's newly elected conservative government made a shocking announcement that the very popular Canadian income trusts which enjoyed certain tax advantages would be taxed just like other Canadian securities. The Harper government exacerbated the situation by not grandfathering any of the long-term investors who already held positions in income trusts.



We thought the impact of this news would be highly negative to the Canadian dollar as foreign capital would quickly flow out of the country. Despite lackluster US economic news at the time, we thought a USD/CAD trade would be profitable because news that affects immediate investment flows typically overwhelms any day to day economic data. Therefore, on November 1, 2006 we went long USD/CAD at 1.1290 and were able to bank 45 points in just a few hours.

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United States dollar vs. Canadian dollar, November, 2006. As investment dollars flowed out of Canada, the USD/CAD trade earned us 45 points.

At 10 to 1 leverage you could have profited $450 on a $10,000 investment on the November USD/CAD trade -- that's a 4.5% profit in a matter of hours.


Next >Five Forex Factors in Synch

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Five Key Factors that Move the Forex Markets -- and How to Profit from Them

The basic building blocks of Forex analysis are relatively simple to understand. Interest rates, economic growth, politics, trade and capital flows, and merger and acquisition activity are the five primary forces that move prices in the currency market. However, while the factors that drive trade are straightforward, actual currency trading can be very tricky.

To forecast the Forex market, you must be able to predict the endless interplay of each of the five forces affecting a currency pair. A currency pair typically driven by economic growth may suddenly be overtaken by influences in trade flows or short-term acquisitions. A pair that seems sure to fluctuate with interest rates may unexpectedly be held back by investors' response to political unrest.
Some investors enjoy solving the puzzle themselves -- spending hours and years analyzing the complex cause and effect relationships between a country's economics, politics, and currency strengths. Others are more interested in reaping the potential rewards, without all the hard work. If you are one of the latter, it makes sense for you to find a qualified Forex analyst and follow their lead.

Articles Web

Forex: Should You Be Trading Trend Or Range? by Boris Schlossberg,

Whether trading stocks, futures, options or FX, traders confront the single most important question: to trade trend or range? And they answer this question by assessing the price environment; doing so accurately greatly enhances a trader's chance of success. Trend or range are two distinct price properties requiring almost diametrically opposed mindsets and money-management techniques. Fortunately, the FX market is uniquely suited to accommodate both styles, providing trend and range traders with opportunities for profit. Since trend trading is far more popular, let's first examine how trend traders can benefit from FX.

Trend
What is trend? The simplest identifiers of trend direction are higher lows in an uptrend and lower highs in a downtrend. Some define trend as a deviation from a range as indicated by Bollinger Band "bands" (see Using Bollinger Band "Bands" to Trade Trend in FX). For others, a trend occurs when prices are contained by an upward or downward sloping 20-period simple moving average (SMA). Get In Early
Regardless of how one defines it, the goal of trend trading is the same - join the move early and hold the position until the trend reverses. The basic mindset of trend trader is "I am right or I am out?" The implied bet all trend traders make is that price will continue in its present direction. If it doesn't there is little reason to hold onto the trade. Therefore, trend traders typically trade with tight stops and often make many probative forays into the market in order to make the right entry.

Liquidity
By nature, trend trading generates far more losing trades than winning trades and requires rigorous risk control. The usual rule of thumb is that trend traders should never risk more than 1.5-2.5% of their capital on any given trade. On a 10,000-unit (10K) account trading 100K standard lots, that means stops as small as 15-25 pips behind the entry price. Clearly, in order to practice such a method, a trader must have confidence that the market traded will be highly liquid.

Of course the FX market is the most liquid market in the world. With US$1.6 trillion of average daily turnover, the currency market dwarfs the stock and bond markets in size. Furthermore, the FX market trades 24 hours a day five days a week, eliminating much of the gap risk found in exchange-based markets. Certainly gaps sometimes happen in FX, but not nearly as frequently as they occur in stock or bond markets, so slippage is far less of a problem.

High Leverage - Large Profits
When trend traders are correct about the trade, the profits can be enormous. This dynamic is especially true in FX where high leverage greatly magnifies the gains. Typical leverage in FX is 100:1, meaning that a trader needs to put down only $1 of margin to control $100 of the currency. Compare that with the stock market where leverage is usually set at 2:1, or even the futures market where even the most liberal leverage does not exceed 20:1.

It's not unusual to see FX trend traders double their money in a short period if they catch a strong move. Suppose a trader starts out with $10,000 in his or her account, and uses a strict stop-loss rule of 20 pips. The trader may get stopped out five or six times, but if he or she is properly positioned for a large move - like the one in EUR/USD between Sept and Dec 2004 when the pair rose more than 12 cents, or 1,200 pips - that one-lot purchase could generate something like a $12,000 profit, doubling the trader's account in a matter of months. (For background reading, see The Most Popular Forex Currencies.)

The Market Always Wins
Of course few traders have the discipline to take stop losses continuously. Most traders, dejected by a series of bad trades tend to become stubborn and fight the market, often placing no stops at all. This is when FX leverage can be most dangerous. The same process that quickly produces profits can also generate massive losses. The end result is that many undisciplined traders suffer a margin call and lose most of their speculative capital.

Trading trend with discipline can be extremely difficult. If the trader uses high leverage he or she leaves very little room to be wrong. Trading with very tight stops can often result in 10 or even 20 consecutive stop outs before the trader can find a trade with strong momentum and directionality.

Bound to a Range
For this reason many traders prefer to trade range-bound strategies. Please note that when I speak of ‘range-bound trading' I am not referring to the classic definition of the word 'range'. Trading in such a price environment involves isolating currencies that are trading in channels, and then selling at the top of the channel and buying at the bottom of the channel. This can be a very worthwhile strategy, but, in essence, it is still a trend-based idea - albeit one that anticipates an imminent countertrend. (What is a countertrend after all, except a trend going the other way?)

Range
True range traders don't care about direction. The underlying assumption of range trading is that no matter which way the currency travels, it will most likely return back to its point of origin. In fact, range traders bet on the possibility that prices will trade through the same levels many times, and the traders' goal is to harvest those oscillations for profit over and over again.

Clearly range trading requires a completely different money-management technique. Instead of looking for just the right entry, range traders prefer to be wrong at the outset so that they can build a trading position.

Putting it into Practice
For example, imagine that EUR/USD is trading at 1.3000. A range trader may decide to short the pair at that price and every 50 pips higher, and then buy it back as it moves every 25 pips down. His or her assumption is that eventually the pair will return to that 1.3000 level again. If EUR/USD rises to 1.3500 and then turns back down hitting 1.3000, the range trader would harvest a handsome profit, especially if the currency moves back and forth in its climb to 1.3500 and its fall to 1.3000.

However, as we can see from this example a range-bound trader will need to have very deep pockets in order to implement this strategy. In this case employing large leverage can be devastating since positions can often go against the trader for many points in a row and, if he or she is not careful, trigger a margin call before the currency eventually turns around.

Solutions for Range Traders
Fortunately, the FX market provides a flexible solution for range trading. Most retail FX dealers offer mini lots of 10,000 units rather than 100K lots. In a 10K lot each individual pip is worth only $1 instead of $10, so the same hypothetical trader with a $10,000 account can have a stop-loss budget of 200 pips instead of only 20 pips. Even better, many dealers allow customers to trade in units of 1K or even 100-unit increments. Under that scenario, our range trader trading 1K units could withstand a 2,000-pip drawdown (with each pip now worth only 10 cents) before triggering a stop loss. This flexibility allows range traders plenty of room to run their strategies.

In FX, almost no dealer charges commission. Customers simply pay the bid-ask spread. Furthermore, regardless of whether a customer wants to deal for 100 units or 100,000 units, most dealers will quote the same price. Therefore, unlike the stock or futures markets where retail customers often have to pay prohibitive commissions on very small size trades, retail speculators in FX suffer no such disadvantage. In fact a range-trading strategy can be implanted on even a small account of $1,000, as long as the trader properly sizes his or her trades.

Bottom Line
Whether a trader wants to swing for homeruns by trying to catch strong trends with very large leverage or simply hit singles and bunts by trading a range strategy with very small lot sizes, the FX market is extraordinarily well suited for both approaches. As long as the trader remains disciplined about the inevitable losses and understands the different money-management schemes involved in each strategy, he or she will have a good chance of success in this market.
To learn more about FX trading, see A Primer On The Forex Market, Getting Started In Forexand Demo Before You Dive In.

by Boris Schlossberg (Contact Author | Biography)

Boris Schlossberg serves as director of currency research at GFT Forex. He is a weekly contributor to CNBC's Squawk Box and a regular commentator for Bloomberg radio and television. His daily currency research is widely quoted by Reuters, Dow Jones and Agence France Presse newswires and appears in numerous newspapers worldwide. Schlossberg has written for publications like SFO magazine, Active Trader and Technical Analysis of Stocks and Commodities. He is also the author of "Technical Analysis of the Currency Market" and the co-author of "Millionaire Traders" with Kathy Lien.

http://www.investopedia.com/articles.../05/050505.asp

[quote=Forexcube;4203287]

http://www.investopedia.com/forex/five-things-that-move-currency-market/free_report_pg5.aspx

Five Key Factors that Move the Forex Markets -- and How to Profit from Them

We decided to go long the New Zealand dollar against the US dollar instead of against the Japanese yen. The risk/reward ratio to go long NZD/JPY versus NZD/USD was not as attractive. Our stop in the NZD/USD was more conservative than the risk we would have assumed in NZD/JPY. Therefore, we went long NZD/USD and banked 40 points over the next 24 hours.


Hi Forexcube,
As usual your postings are very interesting.
Do you mind to talk more about risk reward ratios?, Where can you find risk reward ratios (in numbers) on a specific currency and/or pair? Is risk/reward ration same as risk aversion/apetite? Risk sentiment?
Thank you,
Bcarbon

[quote=bcarbon;4204105] Hi Bcarbon

Nice to hear from you. It's a pleasure for me to point it out in detail in the following days, ... to be headlined "Risk/Reward Ratio".
At first I will copy some definition, may be monday or tuesday, any more I will qualify some aspects the pros and cons and in addition I will explain how traders can assign the R-R-R factor to CCI(14) Tops & Bottom Trading which was one of my principle reasons why Time Cell Trading was full-fledged. I hope that this procedure will receive your endorsement.

Kindest regards
FXcube

The Risk-Reward Ratio

By John Russell, About.com Guide

See More About:

 

1. risk management
2. advanced trading

Know your Risk: The Risk-Reward Ratio

Risk is a part of trading. Every trade carries a certain level of risk. Every trader must know the amount of risk that is being assumed on each trade. Knowing the amount of risk on each trade is one way to limit it and to protect your trading account. The best way to know your risk is to determine the risk-reward ratio. It is one of the most effective risk management tools used in trading.
The risk-reward ratio is a parameter that helps a trader to determine the level of risk in a trade. It shows how much a trader is risking versus the potential reward (or profit) on a trade. While this may seem simplistic, many traders neglect taking this step and often find that their losses are very large.
How to Determine the Risk-Reward Ratio?

The first step is to determine the amount of risk. This can be determined by the amount of money needed to enter the trade. The cost of the currency multiplied times the number of lots will help the trader to know how much money is actually at risk in the trade. The first number in the ratio is the amount of risk in the trade.
The reward is the gain in the currency price that the trader is hoping to earn from the currency price movement. This gain multiplied times the number of lots traded is the potential reward. The second number in the ratio is the potential reward (or profit) of the trade.

Examples
Here are a few examples of the risk-reward ratio:

 

1. If the risk is $200 and the reward is $400, then the risk-reward ratio is 200:400 or 1:2.
2. If the risk is $500 and the reward it $1,500, then the risk-reward ratio is 500:1500 or 1:3.
3. If the risk is $1,000 and the reward is $500, then the risk-reward ratio is 1000:500 or 2:1.

What is a Good Risk-Reward Ratio?

The minimum risk-reward ratio for a Forex trade is 1:2. However, a larger ratio is better. An acceptable risk-reward ratio for beginning traders is 1:3. Any number below 1:3 is too risky so the trade should be avoided. Never enter a trade in which the risk-reward ratio is 1:1 or the risk outweighs the reward.
Many experienced trader will only enter trades in which the risk-reward ratio is 1:5 or higher. This requires that the trader wait for a trade with this ratio, but the reward is worth it. A higher risk-reward ratio is a good idea in case the currency does not make the anticipated price movement. However, if the trader uses a lower risk-reward ratio, there is very little room for smaller price movements and the amount of risk will increase.
The risk-reward ratio is an important risk management and trading tool. It is important for beginning traders to take the extra time to perform this task because it can help to minimize risk in every trade. Waiting for the right risk-reward ratio can take a long time. However, the benefits of waiting for a higher risk-reward ratio are worth the effort and patience. You will know your risk and know your potential profit. Most importantly, you will know whether the trade is worthy of your money.

Related Articles

 

1. Risk Reward Ratio - What is Risk Reward Ratio
2. Risk To Reward Ratio - Definition of the Trading Term Risk To Reward Ratio
3. Win To Loss Ratio - Definition of the Trading Term Win To Loss Ratio
4. Risk for Beginning Traders
5. Stock Investing Is About Risk and Reward - How to Calculate Risk Premium

http://forextrading.about.com/od/bas...kreward_ro.htm

Risk/Reward Ratio


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What Does Risk/Reward Ratio Mean?
A ratio used by many investors to compare the expected returns of an investment to the amount of risk undertaken to capture these returns. This ratio is calculated mathematically by dividing the amount of profit the trader expects to have made when the position is closed (i.e. the reward) by the amount he or she stands to lose if price moves in the unexpected direction (i.e. the risk).


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Investopedia explains Risk/Reward Ratio
Let's say a trader purchases 100 shares of XYZ Company at $20 and places a stop-loss order at $15 to ensure that her losses will not exceed $500. Let's also assume that this trader believes that the price of XYZ will reach $30 in the next few months. In this case, the trader is willing to risk $5 per share to make an expected return of $10 per share after closing her position. Since the trader stands to make double the amount that she has risked, she would be said to have a 2:1 risk/reward ratio on that particular trade. The optimal risk/reward ratio differs widely among trading strategies. Some trial and error is usually required to determine which ratio is best for a given trading strategy.

Related Terms

1. Expected Return
2. Return
3. Risk
4. Risk Management
5. Stop-Loss Order
6. More Related Terms

http://www.investopedia.com/terms/r/riskrewardratio.asp

Reward-to-Risk Ratio

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Another way you can increase your chances of profitability is to trade when you have the potential to make 3 times more than you are risking. If you give yourself a 3:1 reward-to-risk ratio, you have a significantly greater chance of ending up profitable in the long run. Take a look at this chart as an example:


10 Trades Loss Win 1 $1,000 2 $3,000 3 $1,000 4 $3,000 5 $1,000 6 $3,000 7 $1,000 8 $3,000 9 $1,000 10 $3,000 Total $5,000 $15,000

In this example, you can see that even if you only won 50% of your trades, you would still make a profit of $10,000. Just remember that whenever you trade with a good risk to reward ratio, your chances of being profitable are much greater even if you have a lower win percentage.


BUT...
And this is a big one, like Jennifer Lopez's behind... setting large reward-to-risk ratio comes at a price. On the very surface, the concept of putting a high reward-to-risk ratio sounds good, but think about how it applies in actual trade scenarios.
Let's say you are a scalper and you only wish to risk 3 pips. Using a 3:1 reward to risk ratio, this means you need to get 9 pips. Right off the bat, the odds are against you because you have to pay the spread.

http://ads.babypips.com/newads/www/d...&cb=59275ff7df

If your broker offered a 2 pip spread on EUR/USD, you'll have to gain 11 pips instead, forcing you to take a difficult 4:1 reward to risk ratio. Considering the exchange rate of EUR/USD could move 3 pips up and down within a few seconds, you would be stopped out faster than you can say "Uncle!" If you were to reduce your position size, then you could widen your stop to maintain your desired reward/risk ratio. Now, if you increased the pips you wanted to risk to 50, you would need to gain 153 pips. By doing this, you are able to bring your reward-to-risk ratio somewhere nearer to your desired 3:1. Not so bad anymore, right?
In the real world, reward-to-risk ratios aren't set in stone. They must be adjusted depending on the time frame, market environment, and your entry/exit points. A position trade could have a reward-to-risk ratio as high as 10:1 while a scalper could go for as little as 0.7:1.

Previous Lesson Mark Lesson Complete Next Lesson

 

1. What is Risk Management?
2. Capitalization
3. Drawdown and Maximum Drawdown
4. Don't Lose Your Shirt
5. Reward-to-Risk Ratio
6. Summary: Risk Management

http://www.babypips.com/school/rewar...isk-ratio.html

Risk/Reward Ratio in Forex - What Is the Proper Risk and Reward Ratio in Forex Trading?

By Vahid | Category: Forex Basics | Monday, September 28th, 2009

It is very easy to find hundreds of articles about risk/reward ratio in forex trading, but the problem is that most of those articles are not written by real traders who trade for a living or have been working as professional traders for a while. Most of them are written by freelance writers who are paid to write articles or bloggers and webmasters who want to drive some traffic to their weblogs and websites. Most of these writers have never placed any order on the market throughout their lives. The bigger problem is that novice traders believe each and every word of these articles, just because they are published on the internet, but they don’t know that the directions that these articles give are not applicable in live trading. After reading these articles, novice traders try to apply them in their trades and after such a long time of trial and error, they will think that they are not able to follow the trading rules and so they give up, whereas it is the information and directions of the articles that can not be applied in live trading.


For example, on most of the articles you read about risk/reward ratio, it is strongly recommended that novice traders should not even think about taking positions with a risk/ratio of as high as 1:1 or even 1:2 (I will explain what these numbers mean later in this article) and the maximum risk/reward ratio of the positions that new traders take should be 1:3. There is nothing wrong with it so far, but the problem is that these articles never clarify if traders should have a low risk/reward ratio through having wide targets OR tight stop losses. As nobody likes to lose, specially new traders, they all think that they should make their stop loss as tight as possible to have a low risk/reward ratio trade, whereas this is a big mistake. No matter how tight or wide the targets are, a trader can not fool around with the stop loss. Choosing the stop loss has its own rules that can not be ignored or broken. If you set your stop loss tighter than what it has to be, you will be stopped out easily even when your position is correct.


Something that looks even stranger in these articles is that they emphasize that “novice” traders should not take positions with 1:1 or 1:2 risk/reward ratios. Does it mean that experienced traders can do it? Are there different trading rules and techniques for novice and experienced traders? Maximizing the profit and having 1:3 or 1:5 trades can be done by professional and experienced traders, but there are some technical and emotional difficulties in front of novice traders to do that. For example, to achieve a successful 1:5 trade, you may have several losing trades (I will tell you why). This is not a problem for professional traders at all, but for a novice trader who is learning the techniques and has to build his/her confidence at the same time, having losing trades can cause lack of confidence and excessive fear that prevent him/her from advancing to the next steps.
So we can not believe and apply whatever we read over the internet. There are zillions of systems, techniques, indicators, robots and… that are absolutely useless when it comes to live and real trading.


After the above introduction, lets see what risk/reward ratio is and why it is important in forex trading. Risk is the amount of the money that you may lose in a trade. If you have already read the money management article, you know that we should not risk more than 2-3% of our capital in each trade. It means when we find a trade setup and we find a proper place for the stop loss, we have to choose our position lot size in the way that if the market hits our stop loss, we lose maximum 2-3% of our capital. For example we have found a trade setup with EUR-USD that has to have an 80 pips stop loss. We have a $5000 account. If EUR-USD hits our stop loss, we should lose $150 which is 3% of our capital (0.03 x $5000 = $150). It means 80 pips equals $150 (you can use the position size calculator I have on the money management article). This $150 is our risk. But what is the reward? Reward is the profit that we can make in a trade. In the above example, if we choose a 160 pips target for our trade and EUR-USD hits this target, we will make $300 (when 80 pips equals $150, so 160 pips equals $300). This $300 profit is the reward.


So what is the risk/reward ratio of this trade? 150:300 = 1:2
The larger the profit (target) against the loss (stop loss), the smaller the risk/reward ratio which means your risk is smaller than your reward. For example if your stop loss is 20 pips in a trade and your target is 100 pips, your risk/reward ratio will be 1:5 in this trade.


What is the recommended risk/reward ratio in forex trading?
1:3 or 1:5 risk/reward ratio is achievable when the market forms a trend and you succeed to enter on time. In most cases you should be able to hit the top and bottom of the trends, no matter on what time frame you trade. Or if you enter at the middle of the way, the trend should be strong enough to give you another big movement and make a profit which is 3 or 5 times bigger than your stop loss. You can do that. Why not? But there are just a few problems: 1. Markets form a trend in less than 30% of the cases; 2. Some trends are not strong enough that if you enter with delay and while they are at the middle of the way, they can hit your target which is 3 or 5 times bigger than your stop loss. 3. There are many cases that you miss the trends; you hesitate to enter and so you miss the chance; you think you have found a trend whereas you are wrong and it returns and hits your stop loss and… . So you lose in many trades, because you want to catch a big one.


So in reality, you have to lose in many trades, or have many of your trades closed at breakeven by the stop loss (because you will have to move the stop loss to breakeven when you are in a special amount of profit), or not to trade for such a long time waiting for a strong trend, until you can have a 1:3 or 1:5 trade.


How is it possible to catch a 1:3 or 1:5 trade without losing so many other trades?


If you take a position with 1:3 or 1:5 stop loss to target ratio and then you wait for it to hit your stop loss or target, you will have so many losing trades before having a winning trade. The reasons are mentioned above.


The solution is in moving the stop loss. You should not let your stop loss remain at its initial position. To have a 1:3 trade, the distance of your entry and your final target should be splitted into 3 parts (at least), while each part is equal to your original stop loss value. For example if you have a 50 pips stop loss, you should have a final target for 150 pips which should be splitted into three 50 pips levels. Then you should move your stop loss in three stages (in this example I assume that you take a 3% risk in each trade):
1. If the price reaches to the first 1/3 level, you should move the stop loss to breakeven. At this stage, if the price goes against you and hits the stop loss, you will get out without any profit/loss, BUT you should consider that you had an initial risk of 3%.
2. If it reaches the 2/3 level, you should move the stop loss to 1/3 level. At this stage, if the price goes against you and hits the stop loss, you will get out with a profit which equals your initial risk. For example if your stop loss has been 3% of your account, you will get out with a 3% profit. Therefore, such a trade will be ended as a 1:1 risk/reward trade.
3. If it becomes so close to the final target, you should move the stop loss to 2/3 level. Then you have to wait until it hits the final target or returns and hits the stop loss. At this stage, if it goes against you and hits the stop loss, you will get out with a profit which is twice of your initial risk. For example if your stop loss is 3% of your account, you will get out with a 6% profit. Therefore, such a trade will be ended as a 1:2 risk/reward trade. If the price hits the final target, your trade will be closed with a 9% profit and so you will have a 1:3 risk/reward trade.


So, to have a 1:3 trade, you will have some -3% trades which are those trades that hit the stop loss at its initial position. You will also have some 0% trades that are those trades that hit the stop loss at breakeven. Some of your trades will be +3% trades which are those that hit the stop loss at 1/3 level. Some will be +6% trades which are those that hit the stop loss at 2/3 level. And finally, some trades will be +9% trades which are those that trigger the final target.


Now the question is what percent of your trades will be -3%, 0%, +3%, +6% and 9% trades?
It is impossible to answer the above question, because it depends on many things including the trading strategy and market condition. However, there is something that gives us a clue about the number of our 1:3 and 1:5 trades. It is the fact that says market trends only in 30% of the cases and it makes ranging, 70% of the time. To have 1:3 and 1:5 trades, we should have a strong trend, otherwise our stop loss will be triggered in one of the stages before reaching the final target, no matter what time frame you use to take your position.


No need to remind again that in any of the -3%, 0%, +3%, +6% and 9% trades your risk is the same which is 3%. The first conclusion is that taking the risk and the position is up to you, BUT it is the market that determines how your trade should be ended. This is something that all traders, specially novice ones should consider. When you read in different websites and web pages that your trades should only be 1:3 and 1:5 trades, you should consider that you really never know how many of your trades will be ended as 1:3 and 1:5 trades.


That was about risk/reward ratio in general. Now lets become more specific and talk about Forexoma trading signals, their risk/reward ratios and if it is possible to have 1:3 or 1:5 trades with Forexoma signals or not.


The stop loss of the positions that I take are chosen based on the technical analysis rules that I have for myself. I will never break any of these rules. Some traders think that my stop losses are too wide, but they are not. Unlike some other traders who have a constant value for their stop loss (for example any position they take, with any currency pair and any time frame, has a 120 pips stop loss), I mainly follow the rule of thumb we have for setting the stop loss. The rule says that you should place your stop loss in a position that becomes triggered only when the direction you choose is completely wrong. So when I want to set the stop loss, I ask myself under what condition the position I have taken is wrong. The answer I give to this question is the position of the stop loss. In one of the articles I published long time ago, I have explained about setting the stop loss and target orders.


So my stop losses can not be tighter. What about the targets? Can they be wider?


In the way that I choose the entries, most of our trades can have bigger targets and having 1:2 and 1:3 trades is possible with most of the positions we take, because our entry point is always well-chosen. Of course it can be different in different days, weeks and months. I will tell you how to trade my signals in the way that you can have 1:3 trades.


Now the question is if my signals can be used to have 1:3 and even 1:5 positions, why my targets are smaller than what they can be?
As you know in the typical signals that I send the members, usually there are two targets. The first target is usually half of the stop loss size and the second target is the same size as the stop loss. Traders can close 50% of their positions at the first target and then move the stop loss to breakeven. Then they can close the second 50% at the second target. There is a second way too. They can just move the stop loss to breakeven when the price reaches the first target and then close the whole position at the second target. In the last performance report I have published, I have explained 4 different ways that members can trade the signals I send them.
To answer the above question that why my targets are small, I have to say that they are small because there are different traders with different levels of skill among the members. Advanced traders know how to maximize their positions. They just use my signals to enter. However there are many other members who like to take as many positions as they can and they like to see them finished all green and positive. As I said above, they are building their confidence while they are learning the techniques. They need to see the positive result of the things they are learning. They are not disciplined and patient enough yet to maximize their trades and it is so painful to them, if a position which is in a good profit, suddenly goes against them and hits the stop loss at breakeven and they get out without any profit. The tight targets I have in the signals I send the members, are for these members. Unlike the others who believe novice traders should start with 1:3 and 1:5 trades, I believe they should start with 1:1 and even bigger risk/reward ratios to build their confidence. When they become more skilled, which can take them a few years at least, they can maximize their profits and have 1:3 and 1:5 positions. I am 100% sure that those who say novice traders should only take 1:3 and 1:5 positions, are not real traders and know nothing about live and even demo trading. Unfortunately there are zillions of them these days who develop forex websites, weblogs and even robots and e-books. Forex is just a market for them to make money, not through forex trading, but through selling useless forex related products to “novice” traders. http://www.forexoma.com/wp-includes/.../icon_wink.gif


Anyway!
From now on, each signal comes with two sets of targets. In the first set, the targets will be the same as they were used to be in the signals I sent. In the second set, the targets will be for a 1:3 risk/reward trade. The stop loss will be the same in both sets, because as I said I can not make the stop losses tighter. It is up to the members to choose the way they like to trade. We will have enough instructions in members area to help members to take their positions with any level of risk/reward ratio they like.

Should you have any question or suggestion, please use the below comment form.

Thanks for your time http://www.forexoma.com/wp-includes/...icon_smile.gif
Best regards,
Vahid


http://www.forexoma.com/what-is-the-...forex-trading/

Links:
http://forex-strategies-revealed.com...k-reward-ratio
http://www.forex-money-management.com/?page=2
http://www.suite101.com/content/draw...n-forex-a70322
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Why the Risk-to-Reward Ratio is Overrated

By Walter Peters | TradingMarkets.com | May 26, 2010 08:31 AM


Sometimes axioms are repeated over and over, and that is enough for many to accept them as fact. "No pain, no gain" - really? Would every doctor agree with that? "If it sounds too good to be true, then it probably is" - well, truthfully there are homes selling for $1 now, so maybe that isn't true either.

In trading, one of my favorites is "you must aim to get more profit than you risk on each trade." Sometimes this is stated in other ways, such as:

"Always keep your reward to risk ratio greater than 1"
"Only take trades with a minimum of a 2:1 reward to risk ratio"
"If you aim for more than you risk, then you will make money."
"A good reward to risk ratio ensures you to be profitable, winning more than you lose."

Another way of stating this is that your reward to risk ratio must be greater than 1, or 2, or any other number that your favorite trading guru comes up with. Many traders have heard that it is desirable to have a high reward to risk ratio, and it certainly makes it easier for a trader to make money even if the trader has a low win percentage. However, there are many profitable traders who always risk more than they aim to secure in profits. The key to profitability for these traders is that they keep a high win rate.

An example may best illustrate how the reward to risk ratio is calculated:

Trader Amber decides to buy the EUR/USD at 1.3100
Amber puts her stop loss at 1.3050, so her stop is 50 pips away from her entry.
Amber decides to enter a profit target of 1.3200, 100 pips away from her entry.
Thus, Amber is risking 50 pips to make 100 pips.
If we divide the possible gain by the possible loss, we get the reward to risk ratio.
100 pips profit / 50 pips risked = 2:1 reward to risk ratio

In other words, Amber has decided to keep her profit target further from her entry price than her stop loss. This certainly is understandable, but there are many other ways to make money trading.

Keeping a good reward to risk ratio may increase your average win size and decrease your average loss size, but there are other statistics that determine your overall profitability, as a trader.

The most important statistics are as follows:

Percentage of winning trades - W%.
Percentage of losing trades - L%.
Average gain on a winning trade - Ave W.
Average loss of a losing trade - Ave L.

Here's why these statistics are important - with just these four statistics you can find out how good your trading system is, and thus decide if it is worth it to trade the system with real money. With these four statistics you can calculate expectancy of your trading system.

The formula is as follows:

Expectancy = (W% x Ave W) - (L% x Ave L)

The expectancy number tells you how much money you would expect to win over many trades. The best way to get these statistics is to backtest your trading strategy, or employ your trading strategy with a demo account. Do this for many, many trades (at least 50), and then plug in the numbers.

Let's look at a trader, Jeff, as an example:
Let's say that trader Jeff has a trading system that he backtests manually in a demo account for six months, with over 900 trades, and he gets the following statistics.

W% - 70%

L% - 30%

Ave W - $200

Ave L - $420

Calculating expectancy, Jeff sees that (0.7 x 200) - (0.3 x 420) = $140 - $126 = $14.

So, armed with this information, trader Jeff knows that if he takes 100 trades with his system, and the average winning trade is $200, and the average losing trade is $420, with a 70% win rate he is likely to have 70 winning trades, 30 losing trades and he will probably make $1400.

How does Jeff know this? He knows this because he knows that (70 x $200) - (30 x $420) = $14,000 - $12,600 = $1,400.

This doesn't mean trader Jeff will make $1,400. This only means that we would expect him to make $1,400 over 100 trades. Of course Jeff's real results could be a little better or a little worse, but they are probably going to be very near $1,400 after 100 trades.
Many traders, including myself, have gotten into trouble by simply focusing on one part of the equation.
Traders who focus on win rate and forget about average loss size can get into trouble if their average loss gets too big.

This is the sort of problem that many scalpers run into. Scalpers count on a high win rate. Without a high win rate most scalpers will lose
money. This is because nearly every scalper, by definition, will look to take quick profits from the markets, however the scalper will often have a stop loss that is placed further away than the profit target, and this can spell trouble if the win percentage starts to slip. Some scalpers avoid this problem by letting some positions run for a while if they are exceptionally well-timed entries. This will dramatically increase the scalper's average win and can really improve the odds of the scalper's long term survival.
Traders who focus on average win size can get into trouble if they let their win rate get too low.
This problem is common with those traders who are focused on the reward to risk ratio. Sometimes traders become "slave to the reward to risk ratio." Profit targets should be placed where the market is likely to go. Traders who focus too much on the reward to risk ratio can avoid this problem by defining profit targets using sound market analysis, and THEN calculating the reward to risk ratio.
There are many things to think about when backtesting your trading system - the reward to risk ratio will tell only part of the story. If you have a trading system that you think may work, backtest the strategy, and then calculate the expectancy. You may find that that the strategy makes money, even if the reward to risk ratio is not ideal.

Walter Peters, PhD is a professional forex trader and money manager for a private forex fund. In addition, Walter is the co-founder of Fxjake.com, a resource for forex traders. Walter loves to hear from other traders, he can be reached by email at [email protected].


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EURUSD, Daily, 2010 November 29

Looks like "to win the mare or loose the halter".

The whole trick seems for me to wait now. So stay at the sideline and wait.

May be some M1/M5 trades but not at H4 and Daily longer investments till things are getting clearer.

EURUSD, Monthly, 2010 November 29

May be you could reinterpret a downward channel e.g. 1.4120 - 1.1684 since 2008.07.01 if big capital will resolve upon to trade against the Euro.

EURNZD, Daily, 2010 November 29

Daily
Have put the EURNZD at my Watchlist and wait for a price action (engulfing pattern, or a hammer, or an in bar, or something like that) in combination with a CCI(14) bottom, before I could go in the market with some long investments.

There're a lot of indifferent candles around the important support line in the last two weeks.

Monthly
Monthly bar could go further down November, may be December Bar too, before a trend revearsal could come up. I don't know - may be as we shall see later.

Good trading at H1/H4 by waiting for the next breakout before trades at higher timeframes could be done.

to stick to the top attachement,
we see a clear squeeze of the bollinger bands toward the middle one,

en conclusio : a very (big timeframe = big move) big move is coming, i prefer the upside cause as FXcube already said there isn't much space for PA downwards, lot of support here,

lets see....

time round christmas will be smooth also....

EURJPY, Daily, 2010 November 29


Really funny.
EURJPY Daily seems to work out a pattern recognition where you have to count "one", "two" and at "two" you put out your order.
May be it could be better trading the Daily CCI(14) Tops and Bottoms Divergences.


"One Two Sister Nancy - Raggae":