So you learn about ratios and use them in your day to day life (gas mileage, interest rates on loans etc.), why not also use them when trading?
There are many different types of forex traders out there. The short-term scalpers look for a quick one or two pips gains multiple times per day.
Then there are the day traders who try to profit from swings in the market during regular business hours by buying at support levels and selling near resistance levels during various time frames.
Swing traders hold positions for a few days up to several weeks while looking for higher time frame confirmation signals before entering trades.
Position traders hold their trades for months up to years while searching for more significant swings with lower time frame confirmation signals before entering trades.
There are also the macro-traders who look for longer-term trades, in between swing trading and position trading, in which they will hold their trades for months or even years.
Although all these traders may use different time frames, they all have one thing in common: They need to find good risk/reward ratios when entering a trade.
Let’s take a look at how ratios can help traders do that.
Risk Reward Ratio (RRR)
This ratio is simply the number of pips you are looking to make on the trade versus the number of pips you could lose on that same trade.
For example, if there is a pending sell order for 1.3000 and you expect the price to fall towards 1.3000, you could buy that low and wait for a sell signal to exit your trade.
The risk on this trade is one pip because the spread of the bid/asks is sufficient to where price will not move past it during the time frame you are trading in (usually less than 10 minutes). So now we know our risk is at least one pip.
If we only want to make two pips from this trade, then we would need to see a minimum of 3 pips of movement towards us before exiting our trade.
Fibonacci retracement levels can be used as support and resistance when entering trades. They consist of adding or subtracting a % of the current price to an extreme low or high to find possible support and resistance levels.
For example, let’s say we think there will be a significant correction in the market and we see that price has recently reached 1.3000.
The previous swing low was 1.2952, so let’s subtract 38.2% of the distance between those two prices off this new low to get our first Fibonacci level which comes out to about 1.2760
Fibonacci Pivot Points
These are very similar to regular Fibonacci retracement levels, but they are used as, wait for it, pivot points!
They are created using specific Fibonacci ratios (21.6%, 38.2%, 50%, 61.8%) to find possible support and resistance levels for stock or currency within a consolidation period.
So if the price is apparent between the 1.2760 level on the downside and 1.3000 on the upside, this would be an ideal time to do some Sintra range strategy at these levels for more significant gains with less risk.
This one can get a little more complicated but let’s give it a whirl anyway! Standard Fibonacci retracements are used as support and resistance levels when entering trades.
Still, they are created by adding or subtracting multiple different Fibonacci ratios (38.2%, 50%, 61.8%,100%) to find possible support and resistance levels for stock or currency within a consolidation period.
For example, if you look at the Fibonacci extension for EUR/USD, you will see that they are saying it could move up to 1.5000, but it is also likely going to be some significant support around 1.4850 which will act as resistance if the price reaches it.
These are spreads made up of several different trades when your risk on each trade is less than your reward on that same trade. They consist of buying one option and selling another option with different expiration dates (usually three days apart).
The alligator’s mouth consists of the difference between these two trades (the spread).