What is the best risk reward ratio in forex?

There is no best ratio as the choice is personal but in general 1:2 is a commonly used ratio. The issue is how much money is the trader willing to risk? A 1:2 Risk/Reward ratio maximizes profits on winning trades, while limiting losses when a trade moves against. By risking 50 pips to make a reward of 100 pips is effectively inverting these statistics favorably. In other words, have one winning trade for any two given loses to be break even.

For instance:

Win 40% of the time and a 1:2 risk reward ratio on 20 trades

12 losses at $100 loss per trade and 8 wins at $200 profit per trade.

Net result: +$400 (net profit)

Terms such as “pips,” “pipettes,” and “lots” are commonly used by Forex traders which need to be explained.

Definition of a Pip

The unit of measurement to express the change in value between two currencies is abbreviated pip and is a change in percentage points. If EUR/USD moves from 1.1050 to 1.1051, that .0001 USD rise in value is ONE PIP.

Most pairs go out to 4 decimal places, but there are some exceptions like Japanese Yen pairs that go out to two decimal places.

Definition of a Pipette

There are brokers that quote currency pairs beyond the standard 4 and 2 decimal places to 5 and 3 decimal places. These are quotations in Fractional Pips or “pipettes. For instance if GBP/USD moves from 1.30542 to 1.30543, that .00001 USD move higher is ONE PIPETTE at 5 decimal places.

Calculating the Value of a Pip

As each currency has its own relative value, it’s necessary to calculate the value of a pip for that particular currency pair.

Here is a quote with 4 decimal places. Exchange rates are expressed as a ratio (i.e., EUR/USD at 1.2500 written as “1 EUR / 1.2500 USD”)

USD/CAD = 1.0200. US Dollar/Canadian Dollar expressed as 1 USD/1.0200 CAD

Calculation the value change in counter currency times the exchange rate ratio = pip value in terms of the base currency [.0001 CAD] x [1 USD/1.0200 CAD]

OR

[(.0001 CAD) / (1.0200 CAD)] x 1 USD = 0.00009804 USD per unit traded. In this case if 10,000 units of USD/CAD, are traded a one pip change to the exchange rate would be approximately a 0.98 USD change in the position value (10,000 units x 0.0000984 USD/unit).

Now, the question is how to figure out the pip value of this position-- transfer to the pip value of the account currency.

This means that the pip value will have to be translated to whatever currency the account may be traded in. This calculation is multiply/divide the “found pip value” by the exchange rate of the account currency and the currency in question.

The USD/CAD example above, the pip value of .98 USD needs to be transfer to New Zealand Dollars account currency.

0.98 USD per pip X (1 NZD/.7900 USD)

Or

[(0.98 USD) / (.7900 USD)] x (1 NZD) = 1.2405 NZD per pip move

For every .0001 pip move in USD/CAD from the example above, a 10,000 unit position changes in value by approximately 1.24 NZD.