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Trader Tip of the Day: Risk to Reward

Trading is a game of mathematics and the only way to ensure long term profitability is to put the math in your favor.  The easiest way to do this is to calculate the risk to reward ratio for every trade based on your entry, stop and target prices.  For example, if you plan to buy a stock at $50 with a stop price at $49.70 and an offer at $50.60, you are risking $0.30 to make $0.60.  As a rule of thumb, this 2:1 ratio of potential reward to risk should be the minimum acceptable figure for any trade.  By sticking to this rule, you will be recoup the losses on two unsuccessful trade with one successful trade.  Furthermore, remember that the risk to reward ratio constantly fluctuates as the price of the stock moves.  In the previous example, assuming you entered the trade at $50, when the price of the stock reaches $50.50, you are now risking $0.80 to make $0.10; a highly unfavorable ratio.  In order to combat this, consider moving your stop price up or using a trailing stop to put the numbers back in your favor.

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