The One Ratio You Need To Consistently Make Money As A Trader

Written by The Money Lab Team on April 18th, 2016

The One Ratio You Need To Consistently Make Money As A Trader

The most important rule in trading is to manage your risk, plain and simple!

Becoming a successful trader is all about limiting your losses and trying to get price to go in the direction of your trade when you want it to.

Good traders should spend 90% of their time thinking about risk before entering a trade.

Most new traders spend too much time thinking about where they want price to go without spending enough time thinking about where the market can go.

This is the biggest problem with beginner traders!

But the way to fix it is very simple.

It all comes down to one little ratio.

And with it, you can even lose most of the trades you take and still make money!

Interested?

Let me show you...

 

The Simple Rule That’ll Make You A Profitable Trader

 

It’s not easy for a first-time trader to understand what the market is capable of, simply because they have no gauge of what average price ranges are, or have any kind of feel for the market.

From my experience, between the great traders that I know and my time in the market, one thing is very clear…

If you can stick to this one simple rule, you will learn the secret to profitable trading.

What is this rule?

To have a minimum reward to risk ratio of 2:1.

That’s it, that’s the big “secret”!

Plain and simple.

All it means in plain English is that you’re willing to lose half the amount of money you could potentially make from the trade.

I know this is nothing new, and it’s probably not the first time you’ve probably heard about this, but I want to show you why it is so important.

 

 

Why This Ratio Is Key To You Making Money In The Market

 

Let’s pretend for a minute that John (a hypothetical trader for the purpose of this example), believes he has a firm grasp of the market and can accurately predict the market most of the time.

Would you believe him if his account was constantly in a drawdown?

Your answer should be no, of course, because if John was actually pretty good, he should be able to limit the amount of time a trade spends ‘in the red’.

Let’s say John picks a trade and it immediately goes into the green.

The price heads straight towards his take profit, and hits it as he expected it to do when he entered the trade.

I would think, and you should too, that he really had a good trade.

You would say that John really understood when to enter the market and when to take his profit.

Isn’t that what you want for your trades too?

So the most important thing to pick up on with this great trade - pat on the back for John - is that he didn’t risk any money during the entire time that he was in the trade (for the sake of the example, let’s forget about spreads and trading costs for a second here).

You see it’s simple, if you really know what's going on in the market and how your strategy works, you can plan and predict when you'll make money in the market!

Now we know neither you nor I can predict the market perfectly every time, but what we can do is limit the amount that we can lose.

How do we do that?

 

How To Limit Your Risk When You Trade

 

One great way to limit your risk when you trade is to use stop losses (whilst another is to limit the size of the positions you trade).

The first thing you should always do when you set your stop loss is to set it where you think the market will never go (that way you know when your stop loss gets hit that you really were wrong).

And great traders understand the relationship between their stop loss level and their risk to reward ratio.

The smaller you can make the gap between where you think the market can never go, and where you enter a trade, the better you can improve your risk to reward ratio and increase the chances of banking decent profits.

A good starting point for first-time traders, and the most frequently occurring trades, have a 2 to 1 risk to reward ratio.

You really don’t want to play around with a ratio any smaller than that.

Why?

Well you want to instil the kind of mentality that an experienced trader has right from the time that you start trading.

Think of it as building the foundation for your trading house of profit.

But it’s not all about the mentality when it comes to risk management (and this specific ratio).

You have to think of it in terms of probability too.

Wouldn’t you rather want to see yourself making two times the profit for every loss you take?

That’s what this ratio does for you.

By using it as a minimum when you trade, you can make two incorrect trades for every correct trade you call, and you’ll still breakeven.

As a novice trader, this will improve the odds of not blowing your account whilst you get to grips with the market.

Finding ‘perfect’ trades happens far less than you think, so you need to give yourself some room to manoeuvre for those little price moves that go against you.

But as with anything in trading, you need to ‘try it on for size’.

Which means you need to find out what works best for your trading personality and style.

 

The Secret To Money-Making Trades

 

95% of traders who enter the market get wiped out.

That’s a scary stat.

This doesn’t have to happen to you!

You need to think of trading as limiting your risk first, and then focussing on making money.

You do this by setting stop losses on every trade.

Not to mention you need to trade with a risk to reward ratio of 2:1 as a minimum.

Doing this allows you to get more wrong trades than you get right, and still make money in the market. 

It can even help you plan and predict when you'll make money as a trader. 

If you stick to these two rules your trading will turn a corner and you will start making consistent profits from the markets. 

Until then here’s to profitable trading. 

The Money Lab Team