All traders want to find an 'edge', but many don't realise there's a simple and easy tool you can use to ensure your trading is profitable over the long-term.

The tool is the risk/reward ratio, which looks at the potential profit on a trade compared to the initial trade risk. To illustrate how you can calculate it for yourself, we've marked up an example trade set up using the AUD/USD currency pair (where, after a strong decline, we are looking for a sharp reversal higher).

The risk/reward ratio is simply where the potential profit is the distance between the entry price and the target price, and the trade risk being the distance between the entry price and stop loss price. 

To measure the:

• trade risk we subtract the entry price (0.9040 - blue line) with the stop loss (0.8920 - red line). In this example the trade risk is 120 pips.
• potential reward we subtract the entry price (0.9040) with the target price (0.9210 - green line). In this example the potential reward is 170 pips.
• risk/reward ratio we divide the potential reward (170) by the trade risk (120). In this example the ratio equals 1.42.
• potential profit we multiply the dollar amount risked by the risk/reward ratio. As an example, if we were to risk $500 on this trade and assuming the price reaches our target, our profit would be $710 ($500*1.42).

Because many trading strategies, including Rivkin Global's, expect to lose on approximately half of all trades taken, it's important for the profit of winning trades outweigh the loss of losing trades. Generally speaking, traders should seek trades where the profit potential is more than 1.5 times the initial risk, and avoid ones which have a risk reward below 1.

Please note, this trade is purely for illustration purposes.