A risk:reward ratio can play an essential part inyour trading strategy, and ensure that you're not risking too much of your capital. This lesson teaches you howto use ratios effectively.
In this lesson you can learn:
- Why reward:risk probability is important in trading
- What are the most popular reward:risk ratios
- Why probability is the key to every trading strategy
A risk:reward ratio is utilised by many traders to compare the expected returns of a trade to the amount of risk undertaken to realise the profit. To calculate the risk:reward ratio, you need to divide the amount you stand to lose if the price moves in an unexpected direction (the risk) withthe amount of profit you expect to have made when you close your position (the reward).
Some of the most popular reward:risk ratios are 2:1, 3:1 and 4:1,and these will change depending on the strategy of the trade. Of course, there are other aspects which may affect the risk of a trade, such as money management and price volatility, but having a solid reward:risk ratio can play a strong role in helping you to manage your trades successfully.
Example of a Risk:Reward Ratio
Let’s say that you decide to go long on ABC shares. You ‘buy’ 100 lots, equivalent to 100 shares, which are priced at £20 for a total position value of £2,000 - on the basis that you believe the share price will reach £30. You set your stop loss at £15 to ensure that your losses do not exceed £500.
In this case then, you’re willing to risk £5 per share to make an expected return of £10 per share after closing your position. Since you’ve risked half the amount of your profit target, your reward:risk ratio is 2:1. If your profit target is £15 per share, your reward:risk ratio would be 3:1, and so on. Therefore, it’s possible that one profitable trade will cover two, three (or more) losing trades.
It’s important to remember,however, that while risk:reward ratios helps to manage your profitability, they don'tgive you any indication of probability.
The Importance of a Risk:reward Ratio
Most traders aim to not have a reward:risk ratio of less than 1:1, as otherwise their potential losses would be disproportionately higher than any likely profit, i.e. a high-risk trade. A positive reward:risk ratio such as 2:1 would dictate that your potential profit is larger than any potential loss, meaning that even if you suffer a losing trade, you only need one winning trade to make you a net profit.
Invest in Real Stocks & ETFs with 0% commission*For monthly turnover equivalent up to 100,000 EUR (then comm. 0.2%, min. 10 GBP)
Create your account in minutes
Below we have included a table thathighlights different reward:risk ratios and their impact on your total profits and losses. The table below assumes 1 is equal to £100 and you have a win rate of 50% across 10 trades.
You can see clearly from the table below the potential benefits of having a positive reward:risk ratio and how this can impact your net profitability.
Probability Is Key
Wementioned probability briefly above, but let’s take a more in-depth look.
Let’s say that out of your last 100 trades, 60 were profitable. That gives you - or your trading system - a probability score of 60%. Probability depends on your trading system, as well as on your emotional ability to stick to that system.
What’s more, the main objective of every analysis made ahead of entering the market is to maximise the chance of entering a high-probability trade. If you look for a specific technical pattern, you are trying to maximise a probability. Why? Because as it appears, it should be followed by a specific move of the price. By searching for a pattern you are potentially increasing your chances of finding a higher probability trade.
Choose the Right One for You
Each trader has their own trading strategy and risk-reward ratio that is the most suitable for them. One of the challenges of trading is finding a system that works for you and one that ‘fits’ your mindframe.
If we think about risk tolerance on a spectrum, where do you think you would be? Are you risk-averse, cautious and calculated? Or are you open to taking more risk and enjoy the adrenaline?
The most important thing is to choose a system of risks and rewards that is manageable for you, and that potentially increases the chances of your trading being as successful as possible. There’s no specific rule - you just have to find a perfect one that suits your strategy.
This content has been created by XTB S.A. This service is provided by XTB S.A., with its registered office in Warsaw, at Prosta 67, 00-838 Warsaw, Poland, entered in the register of entrepreneurs of the National Court Register (Krajowy Rejestr Sądowy) conducted by District Court for the Capital City of Warsaw, XII Commercial Division of the National Court Register under KRS number 0000217580, REGON number 015803782 and Tax Identification Number (NIP) 527-24-43-955, with the fully paid up share capital in the amount of PLN 5.869.181,75. XTB S.A. conducts brokerage activities on the basis of the license granted by Polish Securities and Exchange Commission on 8th November 2005 No. DDM-M-4021-57-1/2005 and is supervised by Polish Supervision Authority.
FAQs
In many cases, market strategists find the ideal risk/reward ratio for their investments to be approximately 1:3, or three units of expected return for every one unit of additional risk. Investors can manage risk/reward more directly through the use of stop-loss orders and derivatives such as put options.
Is 1:1 a good RR? ›
If you have an edge in the market, your rr should be >1 and your winrate should be above 50%, now you are making money. If it is not, then your analysis is wrong. So the idea is risk to reward should atleast be 1 is to 3.
What is the risk reward ratio in XTB? ›
To calculate the risk:reward ratio, you divide the amount you stand to lose if the price moves in an unexpected direction (the risk) by the amount of profit you expect to have made when you close your position (the reward.)
What is the best risk reward ratio for positional trading? ›
A good risk/reward ratio could be seen as greater than 1:3, where you would risk 1/4 of the overall potential profit. For trading to prove profitable in the long term, a trader should not typically risk their capital for a lower risk/reward ratio, as this will mean that half or more of their investment could be lost.
What is the best risk reward ratio for scalping? ›
For any stock you plan to scalp, you must understand the price supports, resistances and the set-up. From there, you can calculate the share sizing and the probabilities versus the risk. In scalping, a 3:1 risk to reward ratio is common (although, lower risk/reward is always more favorable).
How many percent should I risk per trade? ›
Risk per trade should always be a small percentage of your total capital. A good starting percentage could be 2% of your available trading capital. So, for example, if you have $5000 in your account, the maximum loss allowable should be no more than 2%. With these parameters, your maximum loss would be $100 per trade.
Is a RR of 20 good? ›
The normal respiratory rate for healthy adults is between 12–20 breaths per minute. At this breathing rate, the carbon dioxide exits the lungs at the same rate that the body produces it. Breathing rates of below 12 or above 20 can mean a disruption in the breathing processes.
Is 12 RR good? ›
The normal respiratory rate for an adult at rest is 12 to 18 breaths per minute. A respiration rate under 12 or over 25 breaths per minute while resting may be a sign of an underlying health condition.
What does RR of 1.8 mean? ›
A relative risk of 1.8 indicates that those exposed to a certain risk factor are 1.8 times more likely to experience the outcome than those who are not exposed.
What is a good risk reward ratio Tradingview? ›
Most market strategists and speculators agree that the ideal risk/reward ratio for their investments should not be less than 1:3, or three units of expected return for every one unit of additional risk. Take a look at this example: Here, you're risking the same amount that you could potentially gain.
For example, if you have a $10,000 trading account, the maximum amount you should risk on any single trade would be $200 (2% of $10,000). This means that even if the trade goes against you, you'll only lose a small portion of your overall capital. Adhering to the 2% rule requires discipline and patience.
Is 2:1 a good risk reward? ›
Some of the most popular reward:risk ratios are 2:1, 3:1 and 4:1, and these will change depending on the strategy of the trade.
What is the 1 risk rule in trading? ›
The 1% risk rule means not risking more than 1% of account capital on a single trade. It doesn't mean only putting 1% of your capital into a trade. Put as much capital as you wish, but if the trade is losing more than 1% of your total capital, close the position.
What is the best risk reward trading? ›
To increase your chances of profitability, you want to trade when you have the potential to make 3 times more than you are risking. If you give yourself a 3:1 reward-to-risk ratio, you have a significantly greater chance of ending up profitable in the long run.
Is a higher reward-to-risk ratio better? ›
If your reward is very high compared to your risk, the chances of a successful outcome may decrease due to the effects of leverage. This is because leverage magnifies your exposure, and amplifies profits and losses. Therefore, risk management is critically important.
Is a 1.5 risk to reward ratio? ›
The 1.5 Risk-Reward Ratio: Balancing Risk and Reward
A commonly cited benchmark in trading is the 1.5 risk-reward ratio. This ratio suggests that for every unit of risk taken (usually measured as a percentage or dollar amount), an investor should aim for a potential reward that is one and a half times greater.
What is the risk reward ratio in trading view? ›
The risk/reward ratio measures the difference between the entry point to a stop-loss and a sell or take-profit point. Comparing these two provides the ratio of profit to loss, or reward to risk.
What does 2R mean in trading? ›
This enables traders to express profit and loss as a ratio of R. An example might be a trade with 1R risk of 100 USD which returns 200 USD on winning trades, on average: a 2R return—a R multiple of 2. The same is said for losses.
How to use rrr in tradingview? ›
Using Pinescript to create custom Risk Reward Ratio (RRR) boxes with custom vertical time markers to help traders stay mindful of how long they've been in a trade. //Usage: -Add indicator to chart and you'll be prompted to click three times: -- 1: Choose time (clicking last bar will mark entry as current candle's open) ...
