Who it's for — For those who have constant anxiety about having to "be right" in the markets. With the right math, you can be wrong most of the time and still come out profitable.
The Risk/Reward Ratio (R/R) compares the potential loss of a trade (distance to the Stop Loss) with its potential profit (distance to the Take Profit).
If you risk $50 (1R) to try to make $150 (3R), your Risk/Reward is 1:3.
In simple terms — Flip a coin. If it comes up Heads, you lose $1. If it comes up Tails, you win $3. Do you want to play? Of course. Even if many Heads come up, when Tails comes up you will collect enough to cover three losses. This is the magic of Risk/Reward: it removes the burden of having to predict the future, turning trading into a winning statistical problem.
The relationship with Win Rate (Win %)
Risk/Reward does not exist in a vacuum. It lives in symbiosis with your win percentage (Win Rate). If you have a 1:3 R/R, you can afford to get 70% of your trades wrong and end the week slightly at breakeven/profit!
- Example (10 trades): You get 7 trades wrong (you lose -7R). You get 3 right (you win 3 x 3 = +9R). Net total: +2R. You were wrong almost all the time, yet you made money.
If, on the other hand, you trade with a negative R/R (e.g. 2:1, you risk $100 to make $50), you must have a very high Win Rate (over 70%) just to avoid losing money.
Patience pays off
Beginners often close profits too early to "secure the win", effectively ruining their planned Risk/Reward, and instead let losses run (by removing the Stop Loss) to "hope for a recovery". It is the mathematically perfect way to blow up an account.
Summary Sheet
- The Holy Grail formula: Cut losses short (rigid Stop Loss, 1R). Let profits run (wide Take Profit, 2R or 3R).
- Rule of thumb: Many professionals automatically discard any trade that does not offer *at least* a 1:2 R/R towards the nearest resistance or support.
Links
- r-multiple — How to evaluate all your past and present trades based on risk.
- take-profit — Where the target is set to calculate the reward.
- bronze-path
Module: Module 4 — Risk before profit
The first skill of a trader is survival.
