Anyone who has ever traded probably has heard of, read about, or uses risk and reward techniques. But when you look at trading, what is risk and what is reward? Is risk where you put your protective stop? Is reward where you take profit? The answer to these is both yes and no. The general rule of thumb is to risk one dollar to make two dollars. But would you risk five dollars to make two dollars? Again, the answer is both yes and no.
Where most get risk and reward wrong is that when they enter a trade, they believe that if they put their stop 1 point back from entry and place an exit order to make 2 points of profit then that is good risk management. I disagree. Because if you lose the majority of the time, then odds are you are not risking enough to be paid. Risk is defined by the market you are trading, not by the trader. Traders must trade what the market gives them, and risk what the market tells them to. If the odds are high enough that the trade should work, you may have to risk $5 to make $2. By doing this, you give the market enough room to move around without stopping you out, so you don’t lose money, but make money. So a trader must evaluate risk each time a trade is entered to see if they are comfortable with it. If you don’t like the risk, don’t make the trade.
Traders are always trying to find low risk trades that have the potential for great reward. But, the trader does not dictate to the market where to protective stop goes, but must abide by the market movements. So if a market is has the potential to move up 5 points, and the market dictates that you must risk 5 points to be in it, then the question arises, are you willing to take the risk, or give it time to pull back and try and reduce risk? So before you try to go and simplify risk vs. reward, go and look at the market you are trading and see if it agrees, you might find that the real risk is too high, or you may find that you may not have to risk as much. Good luck trading.