We need to define these first.
What I’m referring to is using a 2:1 or 3:1 Profit to Loss ratio to trade Forex.
Meaning, on a 2:1 ratio, if your stop loss is at 80 pips, your take profit level is at 160 pips.
It now becomes a morbid race to see which level gets hit first.
It’s a very winner-take-all method of trading in a way. Either you win big or lose medium.
Why Do People Use These?
The prevailing thought is by doing this, you have a real money management structure in place (most people don’t), and you are essentially putting the odds of winning in your favor.
There are many problems with this. The first part of the sentence above is correct, but barely. The last part is wrong on so many levels.
So short answer, don’t use them. As usual however, it’s worth your time to stick around for the rest of it.
Major money management information about to hit your eyes, stay tuned.
“But I Have A Structure In Place!”
You do, and it is in fact better than nothing. Most people have nothing.
But man, are you not doing yourself any favors.
Ratios like this sprouted during the popularity of Binary Options, which I will not get into here, but just know it is something I do not do, and I have very good reasons for it — primarily the fact it takes away just about every advantage I have in this game.
Let’s use this blog post to give you a big advantage, shall we?
Your Math Is Off
For starters, a 2:1 or 3:1 ratio doesn’t math out the way you think it does.
DISCLAIMER: I cannot remember where I saw this, and cannot find anything to back up this claim.
Just go with me here.
Let’s say you take a 1:1 ratio, meaning if you have a 100 pip stop loss and 100 pip take profit level, and we knew nothing else about the market:
You would have a 50% chance of price hitting either one before the other.
Once you take this to 2:1 however, you are asking price to go TWICE AS FAR as you asked it to before.
People think you still have a 33% chance to win. You don’t. You’re asking too much. It’s less than 33%.
A lot of people who try and use math here to justify these ratios don’t have the math they think they do in their favor. It throws the equation off, making it invalid.
Ratios Prevent A Major Tactic In Forex
And this tactic dear trader, is called “Scaling Out”.
When you scale out of a trade, you are taking a percentage of the trade off the table.
I only scale out when I’m winning.
Instead of taking 100% of the trade off the table like you would with a 2:1 or 3:1 ratio, you would take HALF of your trade off at SOME profit for example.
So you would do something like this:
- Put your stop loss at -80 pips
- Make your price target 100 pips, but only take HALF of your trade off if price gets there.
- Now move your stop loss to break-even, meaning instead of a -80 pip stop loss, now you have a 0 pip stop loss because you moved it to the place you entered the trade in the first place.
- Let that sucker run
These are example numbers, nothing more. This is not a recommended structure. That blog post is coming soon, fear not.
Why Scale Out?
There is a perceived disadvantage to scaling out.
Often at times, after you take that initial profit, price will retrace and move the other way, often hitting that new break-even stop loss you just made.
In the example above, this makes your 100 pip “win” into a 50 pip win.
And this will happen a lot.
But you WANT it to happen a lot.
Wait until you hear the advantages.
You Prevent Losses
Remember that video I did awhile back about eliminating your mistakes and your losses?
In it, I showed you how every time you prevent a loss, it’s the same as winning a trade. It has the exact same effect on your bottom line, but nobody ever looks at it that way.
Preventing losses is gigantic in the grand scheme of things.
And a 2:1 and 3:1 ratio generates a LOT of losses that don’t have to be.
By scaling out and taking these smaller wins, you’re not only eliminating a lot of these losses, you’re turning them into wins!
The shift here is tremendous.
I don’t want to get too far ahead here, but in the Scaling Out video and blog post (coming soon), I will put up a table that will illustrate just how big of a shift this is.
Done Right, It Can Negate your Current Losses
Look at it another way. If you can make these smaller wins negate your previous losses, you are setting yourself up for great success.
If you can constantly stockpile these small wins, and you can easily do this, you can keep your account at a break-even level.
This doesn’t excite you? It excites me.
If you can use small wins to completely negate your losses, you get to do something awesome.
You get to…..
Put The Big Wins Directly Into Your Pocket
How sweet it is!
Not every trade will return back to your break-even stop loss and hit it.
Sometimes trades run. And they can run far. 500-1500 pips far.
And if you’ve already put in the work to negate your losses, these pips go straight into your pocket.
…..okay, half of them do, since you’ve taken half of the trade off a long time ago, but still. 250-750 pips? Who wouldn’t want that?
This is how I make my money in Forex trading.
I take a measured, disciplined approach to make sure my small wins take care of my losses.
Then when it’s time for a big run, I make sure I’m in it. Because very currency pair has a few good runs in them every year on the daily chart.
I’m making sure I’m in as many as possible, because this is my profit. This is where it comes from.
But I can’t do that, at all, if I have a 2:1 trading ratio. I take myself out of this profit pool completely.
Do not take yourself out of this profit pool.
Do not take these long, profitable runs and say “No, I choose not to participate in these”
There is not one reason you can give me, strong enough to mitigate losing out on big runs in the market.
So just don’t use these ratios, ever.
I’ll give you something you CAN use soon, but as I always do, I want to steer you away from the bad stuff first, so you can approach the rest of it with a blank slate and an open mind.
Because as I’ve proven over and over, my way is better.