Since I want to learn more about risk management I came across this article from Steve Connell. What do you think about this? http://forexop.com/strategy/stop-loss-p ... x-returns/
Steve Connel:
(...)Forex trading forums are full of well meaning, yet rather misguided advice about risk-reward setups and how to set your stop losses. Unfortunately, many of these people fail to understand the true meaning of risk or reward.
The idea that simply setting your stop loss smaller than your take profits will achieve a certain risk reward is complete nonsense.
Using risk/reward to set your trade entry and exits does not make any sense unless you know the probability of outcomes in a given trade.
Take this simple example. Suppose there is a lottery costing $1 to enter. The prize is $1m. By the definition of the naïve trader, this gives:
Risk: $1
Reward: $1m
Reward/Risk ratio: 1,000,000
By that definition, this would seem a fantastic game to play. However, suppose we know that two million people enter the lottery. This makes the odds of winning 1:2,000,000 (one in two million). Now we know the odds, we can calculate the true risk reward:
True risk: p(loss) x E(loss) = (1- 1/2000000) x ($1)
True reward: p(win) x E(win) = (1/2000000) x ($1,000,000)
True reward/risk ratio: 0.5