The most important factor in becoming an effective trading professional is the management of risk. The most effective way to manage the risks associated with forex trading is to utilize the risk-reward ratio (RRR).
While the aspect of risk management is crucial for traders, they face difficulties in developing it. This problem can be solved by the risk-reward ratio indicator.
The Basics
The Risk-Return indicator allows traders to identify the level of risk exposure and potential reward. The indicator appears on the main page of the chart and its number is shown in the chart below.
In addition, the indicator shows 3 horizontal lines. The first line represents the price level at which the profit was taken (green horizontal line). The second line represents the price level at which a stop loss is set (red horizontal line). The third line in the chart (gray horizontal line) is the buy price.
The Risk-Return indicator for calculating the Risk-Return indicator for MT4 is calculated by using one of the following methods
The danger lies in the change between the entry point and the stop loss point of the trade.
For long term trades, the risk is the entry price – SL
For short-term trades, the risk is SL minus the entry price.
There is an incentive factor in the difference between the entry point and the stop loss point.
For long term trades, the incentive = TP + Entry
For short term trades, the reward is the entry and TP.
This is divided into the RRR (reward/risk) of risk.
For example, if you open a long trade in USD/JPY at 125.22, if you change SL as well as TP to 122.11 and 128.54 respectively, because it is a buy trade, the risk you take is
Entry – SL = 125.22-122.11= 3.11
The return you get is
Entry – Entry = 128.54 – 125.22 = 3.32.
The risk can be 3.11 and the reward is 3.32.
RRR = reward/risk = 3.32/3.11 = 1.1
Therefore, RRR is equal to 1:1.1.
How can I make use of the Risk-Return indicator?
After you have dragged the indicator onto the chart and held down CRTL B., you can mark the three icons below.
After you have identified the icons, three horizontal lines will appear on the chart. You can also move the Take Profit and Stop Loss levels to determine the risk-reward ratio for each trade. When adjusting the Take Profit and Stop Loss levels, the indicator will show the risk-reward ratio.
In a long trade, the TP level (green horizontal line) must be placed above that entry point. In contrast, it is recommended that the SL level (red horizontal line) should be placed below the entry point.
By using this indicator, traders can distinguish between bad and good trades. Good trades should have a ratio of at least 1:1. However, negative trades are likely to have an RRR lower than 1:2.
For a 1:2 RRR, it means that when you take a risk of 1, your reward will be twice as much as your risk. In addition, a 1:3 means that when you take a risk of 1, your return will be three times your risk. This means that if the SL is 30 points, you will get 3 times your risk and your return will be 3×30 points, or 90 points for 1:3. For 1:2, if SL is 30 pips, this means that your profit is 30×2=60 pips.
This is why this indicator is crucial to evaluate the risk-reward ratio before you start any kind of trading.
Summing up
MT4’s Risk-Return indicator is a very useful tool for all Forex traders. The indicator allows traders to assess the level of risk they are exposed to, if they can see price movement against them, and the return if the price is in their favor.
