Stoploss is the price at which trade will get closed if the market moves against the open position. Suppose if a trader buys EURUSD from 1.2050, then he can place a stop loss to 1.2030 below the buy price. So whether if the market falls below his buy price, the trade will close at 1.2030 with a maximum of 20 pips loss.
Take profit is the price at which trade will get closed if the market moves above the open position. Suppose if a trader buys EURUSD from 1.2050 and place a take profit target to 1.2080 above the buy price. So whether if the market rises above his buy price, the trade will close at 1.2080 with a maximum profit of 30 pips.
Profit Loss in Forex:
In forex how much profit you will make or lose that depends on, how much pip you have earned or lost.
If a trader buy EURUSD 1 standard lot at 1.2550 and target is 1.2580 with a stop loss of 1.2530, that indicates his stop loss is 20 pips and take profit is 30 pips.
If the market instead of rising fell below the stop loss, then the trader will lose 20 pips. With 1 standard lot pip value for EURUSD is $10, therefore, maximum loss will be $200 and the maximum profit will be $300. The maximum loss is the risk and maximum profit is the reward for this trade.
Risk Reward Ratio:
The risk-reward ratio is calculated by dividing the risk amount with the reward amount. This is the most important factor in trading. Before placing a trade trader needs to decide whether taking a particular trade will be worthy or not. In the general case, the reward should be always greater than the risk.
With the above example, the risk-reward ratio was 1:1.5 with 20 pips stop loss and 30 pips take profit. That means you will earn 1.5 pips for every 1 pip you have risked.
If you had take profit of 40 pips with 20 pips stop loss, then risk-reward will be 1:2
Risk reward ratio dependency with winning rate
The long-term growth of a trading account highly depends on risk-reward ratios. Constantly no one can achieve a 100% winning rate. Thus if a trader has a 50% winning rate, i.e winning 5 out of 10. Then with a 1:2 risk-reward ratio, a trader will still make money.
With 1:2 risk reward ratio if take profit is 30 pips then stop loss will be 15 pips. Therefore losing 5 times and winning 5 times. Net balance will be as followings:
Total loss: 5×15 = 75 pips
Total loss: 5×30 =150 pips
Net: 150-75 = 75 pips
Breakeven Point is the area, where a trader will neither make the profit nor make the loss, a zero level area. Anything above break-even point is profit and anything below break-even point is a loss.
With a 1:2 risk-reward ratio you can reach to break-even point even with a 33% win rate. The following table shows how the risk-reward ratio is associated with the break-even point.
|Risk reward ratio||Minimum percentage for breakeven|
With the table, you can see higher the risk-reward ratio, the lower winning rate required to reach breakeven. That is the benefit of high quality trading.
Last but not least, Swap charges are applicable if a trade stays open overnight. Then the trader has to either pay money to the broker as swap charges or receive positive swap charges from the broker. It is also termed as swap rollover fees or swap fees.
Different currency pairs have different swap charges based on the trading volume.
For Islamic accounts, swap charges do not apply for religious practice.
For SELL orders, the trader will receive positive swap fees. This means extra money will be added to your trade.
For BUY orders, a trader has to pay the swap fees along with that trade. Therefore he needs to earn enough profit to recover swap fees for the overnight trades.
Suppose a trader earned 20 pips in a buy order and his profit with one standard lot is $200. Therefore if that trade gets closed overnight then let us say he has to pay swap fees of $6.45 and his net profit will be $193.55.
If that trade gets closed after 2 days. Then his swap fees will be $6.45×2 = $12.90 and net profit $187.1.
Longer he will hold the trade and market will not move more than 20 pips he will lose the value of the trade. But if the market rises and moves more than 20 pips then his swap fees will get adjusted.
In case of a sell order, the opposite happens, positive swap fees will be added to the main profit.